OECD Economic Outlook, Volume 2023 Issue 1

Israel

GDP is projected to grow by 2.9% in 2023 and 3.3% in 2024. Elevated inflation will weigh on private consumption growth and exports will be held back by moderate demand growth in trading partners. The increase in interest rates will slow investment growth. Growth is projected to pick up towards its potential rate in 2024 as inflation abates. Risks are skewed to the downside, related to high global uncertainty and domestic political tensions.

Tight monetary conditions should be maintained to bring inflation back to the target range. Fiscal policy should avoid adding to demand and inflationary pressures, and support to mitigate rising costs of living should become more targeted. Reforms to reduce import barriers and spur competition should continue. Labour market and educational reforms are needed to address demographic challenges and reduce wide labour market disparities.

Economic activity is moderating but remains robust

GDP growth moderated in the first quarter of 2023, but remained robust at 2.5% at an annualised quarterly rate. Private consumption contracted but private investment growth was strong. Business confidence has weakened but remains positive. Activity in the housing market continues to moderate, with the number of housing transactions declining. Capital raised by high-tech firms has declined considerably compared to the high levels in 2021 and early 2022. The shekel has depreciated in the first five months of the year and the stock market has markedly underperformed global indices. The labour market remains tight despite some recent easing. The job vacancy rate continues to decline, especially in the high-tech sector, but is still above pre-pandemic levels. Consumer price inflation, at 5% in April 2023, is above the 1-3% central bank target range and is broad based. Inflation of tradables has slowed, but housing and service inflation is persistent. One-year ahead inflation expectations hover around 3%.

Israel: Inflation and housing indicators

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

Source: Israel Central Bureau of Statistics; Bank of Israel; and OECD calculations.

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Israel: Demand, output and prices

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The effect of global energy price developments on domestic prices is limited due to Israel’s self‑sufficiency in natural gas, government measures and the regulation of most energy prices. Regulated electricity prices were lowered recently due to lower prices of imported coal used in electricity generation, but electricity prices remain slightly higher than in late 2022. Russia’s war of aggression against Ukraine has led to a significant increase in immigration, with around 58 000 (0.6% of the population) new immigrants from Ukraine and Russia having arrived in Israel in 2022.

Monetary conditions have tightened

The central bank raised the policy rate from 0.1% to 4.75% between April 2022 and May 2023. Higher interest rates have led to a marked decline in the volume of new mortgages. Tax revenues are slowing as GDP growth is moderating and some transitory factors, for instance related to high real estate valuations, are dissipating. The budget for 2023 and 2024 foresees some moderate increase in spending. The budget balance will turn from a small surplus in 2022 to a deficit slightly above 1% of GDP in 2023 and 2024. To mitigate the increase in the cost of living, the government extended the expansion of child tax allowances and the reduction of the coal excise tax until end-2023, and the reduction of the excise taxes on gasoline until end-2024.

Growth is set to moderate

GDP is projected to grow at a more moderate pace in 2023 and 2024. Export growth will be held back by modest external demand growth. Elevated inflation is weighing on real disposable income and private consumption growth. The increase in real interest rates and high uncertainty is 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 range, supporting a pickup in domestic demand in 2024. Risks are skewed to the downside. An escalation of the conflict in Ukraine could adversely affect the economy via lower demand from trading partners and a re-intensification of pressures in global energy markets leading to higher inflation. Higher global and domestic interest rates could lead to increased volatility in financial markets. A more pronounced slowdown in the global hi-tech sector would also adversely affect growth in Israel. Heightened security incidents and continued political tensions around the judicial reform could increase risk perceptions, lead to tighter financial conditions, and weigh on business sentiment and investment.

The macroeconomic policy stance should remain tight

Monetary policy conditions should remain tight until inflation is firmly on a path towards the inflation target. Fiscal prudence is needed to avoid adding to inflationary pressures. Policy support to mitigate the rise in energy costs should become more targeted on the most affected households and firms, for example via temporary and targeted transfers instead of reductions in energy excise taxes. Reforms to reduce tariff and non-tariff import barriers and to spur competition should continue as they reduce the cost of living and boost productivity. Addressing demographic challenges, related to the rising share of population groups with weak labour market attachment, is crucial to maintain future growth and fiscal sustainability. This will require setting appropriate work incentives, better supporting working parents including by expanding child‑care facilities in underserved areas, improving skills at all stages of the learning cycle, as well as facilitating mobility towards high productivity jobs and firms.