After about a year and a half of stability and even a slight reduction in the Bank of Israel’s interest rate, Moody’s double downgrade increases the likelihood of another hike – a blow for mortgage borrowers and, as a result, also for the housing market. Raoul Serugo, President of the Contractors Association, points out that the labor shortage was cited by Moody’s as one of the key reasons for the downgrade: “The government must now decide on a fast-track process to address this shortage.”
By Nimrod Buso, Nadlan Center
Last Friday, alongside the first reports of the assassination of Hezbollah leader Hassan Nasrallah, the Israeli economy also suffered a significant, and some might say surprising, blow with a two-notch downgrade of Israel’s credit rating from A2 to Baa1 (also known as triple B1). This comes just five months after Moody’s first downgrade from A1 to A2 in April this year. This is Israel’s lowest credit rating since 1995.
Israel’s transition from a historically strong economy to the same credit rating group as Bulgaria, Peru, and Thailand is expected to have far-reaching effects on the entire economy, including a clear impact on the Israel real estate sector. The main risk, it seems, lies in the growing chances of a rate hike by the Bank of Israel due to the downgrade.
“The downgrade increases the likelihood of a rate hike as all loans from abroad will become more expensive,” says CPA Rotem Zilber, a partner at BDO. “This means that the cost of capital is becoming more expensive for the Israeli government, and the rest of the market adjusts accordingly. The interest rates for corporate bonds maintain fixed spreads compared to government bonds.”
It is worth noting that the last time the Bank of Israel raised the interest rate was in May 2023, when the monetary committee raised the rate from 4.5% to 4.75%. This increase followed a series of sharp rate hikes, but since then, aside from a single reduction of 0.25 percentage points in January 2024, bringing the rate back to 4.5%, there have been no further changes. One of the positive outcomes of stability over the past year and a half has been the housing market’s recovery after transaction volumes dropped by tens of percentage points in 2023. However, another rate hike is expected to rock the boat.
Zilber states, “The downgrade emphasizes the decline in the rating agencies’ confidence in Israel’s ability to handle current economic and political risks. The move from the A rating group to the triple B group is a clear sign of increasing investment risk in Israel. A Baa1 rating is the lowest and still considered an investment grade, but it suggests that Israel is closer to risky territories than before.”
“As a result, Israel’s debt cost has risen significantly. The spread between the yields on Israel’s 10-year government bonds and U.S. government bonds has widened considerably in recent months, illustrating the market’s perceived risk regarding investment in Israel.”
One of Moody’s key reasons: failure to address the labor shortage
Raoul Serugo, President of the Israeli Contractors Association, stated today that “the credit rating downgrade will increase the national debt’s financing costs, deepening the deficit and making it harder for the government to cut its budget and adopt aggressive policies to curb inflation. Under these conditions, the Bank of Israel may raise interest rates in the economy, burdening mortgage holders and reducing demand for housing, leading to a further drop in housing starts.”
Serugo also said, “One of the four reasons Moody’s cites as a key factor in the decision is the government’s failure to address the labor shortage in the construction and infrastructure sectors. The government must now decide on a fast-track process to address this shortage. Such a time-bound decision may allow for a rating correction and partially prevent the economic blow to the economy.”
S&P and Fitch are likely to follow with downgrades
An analysis published today by Bank Hapoalim noted that “a Baa1 credit rating typically applies to countries far less wealthy and developed than Israel. Israel’s GDP per capita is significantly higher than that of the other countries. Spain is the closest to Israel, but Spain has a public debt of 106% of its GDP. It’s hard to argue with the credit rating of a country at war because the range of possible scenarios is vast. However, we tend to believe that Israel’s economic data will justify a higher credit rating when the war ends, even if we see the debt continue to rise along the way.” The report also mentioned that “a large gap (three notches) has now emerged between Moody’s rating and that of S&P. The country risk premiums in the markets align more with Moody’s rating. It is likely that S&P and possibly Fitch will respond with downgrades.”
The report further stated that “interest rates will not decrease soon. The country’s risk has increased, as have inflation risks. The derivatives market now reflects stability in interest rates until the third quarter of 2025. The inflation forecast for the next 12 months stands at 3.0%, and we believe the risks are tilted upward, given the high government deficit, labor shortages, and rising rental prices.”
