(Bloomberg) -- Israel’s central bank is staring at the possibility of keeping interest rates on hold for the rest of the year, after earlier signaling as many as three cuts to help an economy whipsawed by war.

A record ramp-up in budget spending is feeding through to inflation that’s approaching the top of the government’s 1%-3% target range after a two-month acceleration. A likely later start to rate cuts by the US Federal Reserve will probably shift the timeline for the Bank of Israel’s easing as well.

Israeli policymakers have increasingly adopted a more neutral bias after a rate decrease to start the year, with the war against Hamas now dragging on for more than seven months. Economists surveyed by Bloomberg are unanimous for the first time since November that the monetary committee will leave its benchmark at 4.5% for a second straight meeting on Monday.

Citigroup Inc. no longer expects Israel to resume reductions this year and Bank Hapoalim calls them “far from certain.” Traders have also unwound bets that further easing is imminent.

“There is greater concern that interest rate gaps between Israel and the US could lead to a further depreciation of an already volatile shekel and increase inflationary pressure,” said Ronen Menachem, chief market economist at Mizrahi Tefahot Bank.

A wider rate differential between Israel and the US threatens capital inflows and could undercut the local currency. Though the shekel has recently recouped some losses suffered in March-April, its three-month historical volatility at over 10% trails only Chile’s peso and the Russian ruble among a basket of 31 major currencies tracked by Bloomberg. 

“The central bank would always rather risk a too-high-for-too-long interest rate — although that can affect growth — over a hasty cut that could lead to inflation rising and rates possibly ending up even higher than before,” Menachem said.

Ahead of the rate decision on Monday, the shekel traded 0.5% weaker against the dollar as of 2:49 p.m. in Tel Aviv, on track for its biggest loss in more than a week. It’s down about 1.7% in the year to date.

Israel’s war bill has already amounted to $16 billion, swelling the 12-month trailing budget deficit to 7% of gross domestic product as of April. Bank of Israel Governor Amir Yaron has repeatedly called on the government to adopt a responsible fiscal policy in the face soaring defense outlays. 

“Increased government spending and a growing deficit are also contributing to inflationary pressures, and in such circumstances it is likely for the central bank to adopt a more restrained monetary policy,” said Asher Blass, a former chief economist at the Bank of Israel.

Price pressures are intensifying just as the outlook dims for Israel’s economy after a bounce-back in the first quarter. The conflict’s duration and intensity present the biggest uncertainty, with the military now expanding operations in Rafah against Hamas and still engaging in combat against the Lebanese militia Hezbollah in the north.

Industries from construction to retail trade remain swept up in the disruption from the fighting. As a result, economic growth is on track to moderate in the coming quarters even as GDP remains 2.8% below its pre-war level. 

While the Bank of Israel projects the economy will expand 2% this year, S&P Global Ratings and Moody’s Investors Service see a much weaker pick-up closer to 0.5%-0.6%. 

But the central bank has less room for stimulus now that inflation is reviving, in an upswing that took it to 2.8% in April, the fastest this year. A survey by the central bank found expectations for price growth a year ahead inched up for a fifth straight month in May and reached 3%.

Faster increases in the cost of food, especially dairy products, will likely keep up the momentum of inflation this month, with the cost of air travel also sharply on the rise. 

Analysts at Bank Hapoalim’s financial division forecast price growth at 3.2% in 12 months and “assess that the risks are skewed toward higher inflation,” according to a report. “Interest rate reductions will wait,” they said.

Economists at Goldman Sachs Group Inc. reversed their forecast for a rate cut on Monday and now expect no change, “as two recent upside surprises to inflation, increased inflation expectations, and continued high geopolitical uncertainty lead us to believe the Bank of Israel will hold off on easing policy.”

Still “looking further ahead, we maintain a relatively dovish view on Israeli rates,” they said, predicting a cutting cycle will start in the third quarter. “Shekel strength is likely to provide a disinflationary impulse in the months ahead.”

--With assistance from Joel Rinneby.

(Updates with shekel’s performance in eighth paragraph.)

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