OECD Economic Outlook, Volume 2022 Issue 2

Israel

GDP growth is projected to moderate from a strong 6.3% in 2022 to 2.8% in 2023 and 3.4% in 2024. The global slowdown is set to weaken demand from Israel’s trading partners. Elevated inflation will slow disposable income and private consumption. Increasing interest rates and lower stock market valuations will weigh on investment. Growth is projected to pick up towards its potential rate in 2024 as inflation abates. Risks are skewed to the downside, and particularly related to a continuation of Russia’s war of aggression against Ukraine.

The gradual tightening of monetary policy should continue in order to bring inflation back into the target range. Fiscal policy should avoid adding to inflationary pressures while allowing for temporary and targeted support to households and firms most affected by rising costs. Recent reforms to reduce tariff and non-tariff import barriers are welcome and should continue. The expansion of renewable energy should be promoted by removing administrative barriers and investing in storage and transmission capacity.

Economic activity is robust

GDP growth moderated to 2.1% (annualised quarterly rate) in the third quarter of 2022. Private consumption contracted slightly, but investment expanded robustly. Confidence in the business sector remains positive. The labour market is tight, with employment above pre-crisis levels. The vacancy rate has stabilised at a historically high level in recent months. Consumer price inflation, at 5.1% in October, is lower than in most OECD countries, but is above the central bank’s 1-3% target range. Inflation has become increasingly broad‑based, with about three-quarters of the components of the consumer price index growing faster than the central bank’s target. One year-ahead inflation expectations are around 3%. Real wages have declined somewhat in recent months, despite robust nominal wage growth.

Israel

1. Shaded area is the Bank of Israel's inflation target range (i.e. 1-3%).

2. The job vacancy rate measures the proportion of total posts that are vacant, expressed as the ratio of the number of job vacancies to the number of occupied posts plus the number of job vacancies.

Source: OECD Consumer Price Statistics database; and Israel Central Bureau of Statistics.

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Israel: Demand, output and prices

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Russia’s war of aggression against Ukraine continues to put pressure on global energy and food prices, although energy price effects in Israel are more limited given the country’s self-sufficiency in natural gas. The war weighs on demand from trading partners in the short term. In the medium term, Israel may benefit from increased defence exports and natural gas exports to Europe. Immigration from Ukraine and Russia has increased significantly, accounting for around 0.3% of the population in July. The pronounced decline in technology stock markets since the beginning of the year is weighing on financing conditions for the high-tech sector.

Macroeconomic policy is tightening

The central bank has raised the policy rate five times in 2022, from 0.1% to 2.75%. Quantitative easing measures, including the purchase of government bonds, ended in late 2021. The central bank has signalled that the pace of further interest rate increases will be determined by inflation and activity developments. The OECD projections assume that the policy rate will reach 4.25% in the second quarter of 2023 and remain at that level until the end of the projection horizon. The budget deficit continued to narrow considerably in 2022 thanks to the phasing out of pandemic support and strong revenue growth. Revenue growth is expected to slow as the recovery moderates and some transitory factors, related to high real estate valuations and surging corporate profits, dissipate. Measures taken to mitigate the increase in the cost of living, such as an expansion of the earned income tax credit and child tax allowances, as well as temporary reductions of coal and transport fuel excise taxes, are estimated to cost around 0.7% of GDP in 2022. A budget for 2023 has not yet been submitted due to the political situation. The projections assume that some support measures will be extended in 2023 before being largely phased out in 2024, with the fiscal stance being broadly neutral in both years.

Growth is set to moderate

The global slowdown will lower demand from Israel’s trading partners. Elevated inflation is weighing on disposable income and private consumption growth. The increase in real interest rates and high uncertainty are set to slow investment. The labour market will slightly cool as growth moderates. Inflation should gradually slow towards the mid-point of the central bank target, supporting a pick-up in domestic demand in 2024. A prolonged conflict in Ukraine could adversely affect the economy through more persistent inflation and lower external demand. An increase in security incidents could heighten uncertainty, weighing on consumption and investment.

Policy support should be temporary and targeted

Consumer price inflation above the central bank’s target range and robust domestic demand call for a continuation of the gradual tightening of monetary policy. Fiscal policy should remain tight so as not to add to inflationary pressures and not to require even tighter monetary policy. Additional fiscal policy support to mitigate the increase in energy prices and broader costs of living, if needed, should be temporary and well targeted on the most vulnerable households and firms, be aligned with environmental goals and preserve energy savings incentives. Boosting renewable energy is needed to accelerate the green transition but requires investment in transmission and storage infrastructure as well as removing administrative barriers. Recent reforms to reduce tariff and non-tariff import barriers, including for foods, are welcome as they can both reduce the cost of living and spur competition and productivity.