The Bank of Israel is moving from wartime caution to cautious relief, cutting the benchmark interest rate to 3.5% after inflation stayed under control and the immediate economic shock from the Iran confrontation began to fade.

The move, approved by the Monetary Committee headed by Governor Amir Yaron, lowers the rate by 0.25 percentage points from 3.75%. It is another signal that Israel’s economy is stabilizing after months of heavy security pressure, even as the central bank made clear that this is not a victory lap. The region is still volatile, the North remains tense, and defense spending could still reshape the entire economic picture.

The bank said inflation is sitting near the middle of its target range, with annual inflation at 1.9%. Lower energy prices after the U.S.-Iran memorandum of understanding, a calmer risk premium, and easing supply constraints all helped create room for the cut. The shekel has remained a major part of the story, its strength has helped cool import prices, but it has also created pressure on exporters and Israel’s high-tech sector, two engines of the country’s growth.

For households and businesses, the cut should offer some relief, especially for borrowers exposed to prime-linked loans and mortgage tracks. But the effect will be gradual, not instant. Housing costs are still sticky, with the housing component of the CPI rising at an annual pace of 4%, and leases for apartments with new tenants rising far faster. That means Israelis may see some easing on credit before they feel real relief in rent or cost of living.

Finance Minister Bezalel Smotrich immediately argued that the move was too small, saying a sharper cut is needed to help households, businesses, exporters and high-tech. The tension is clear as politicians want faster relief, while the central bank is trying to lower rates without reigniting inflation or weakening Israel’s financial credibility during a security-heavy year.

The Bank of Israel’s updated forecast is cautiously strong. It expects GDP to grow 4% this year and 5.5% next year, with inflation at 1.8% in both years. It also sees the interest rate falling toward 3% within a year. But that forecast rests on major assumptions: no renewed fighting with Iran, lower-intensity fighting in Lebanon, and no major expansion of the defense budget beyond what has already been reserved.

Israel’s economy is proving resilient, with a tight labor market, strong credit activity, and high-tech still raising billions. But the cost of defending the country is not disappearing. If defense spending rises sharply, the bank warns the deficit could widen and inflation could move higher again.

The rate cut is a vote of confidence in Israel’s recovery. It is also a reminder that the economy is still tied to the battlefield. The stronger Israel’s security position holds, the more room the country has to breathe financially.