OECD Economic Outlook, Volume 2018 Issue 1

Israel1

Growth is projected to strengthen to over 3½ per cent in 2018 and 2019. Support from fiscal easing, very low interest rates and a stronger external environment will boost demand and employment. In a tight labour market, rising wage pressures are projected to lead to a steady increase in inflation.

The monetary authorities must stand ready to gradually raise interest rates once inflation is sustainably back in the 1‑3% targeted range. Higher social spending and expenditure on education and health care are welcome to foster more inclusive growth. The financing of these expenses with sufficient revenues would preserve budgetary room for manoeuvre and lower the risk of overheating. Reducing the existing large social disparities will be beneficial for growth, but will also requires intensifying structural reforms that improve the skills and productivity of disadvantaged groups.

Activity remains vigorous

GDP growth accelerated to around 4¼ per cent year‑on‑year in the last quarter of 2017 and first quarter of 2018. Despite a decline in residential investment, activity remained solid at the beginning of 2018, with strong public consumption and good export performance, particularly of services. Although partly offset by imports, household spending and business investment were exceptionally vigorous due to a sharp rise in car sales in advance of a programmed change in vehicle taxation in January 2019. The unemployment rate fell to 3.6%, and the vacancy rate is rising in most sectors, fuelling wage pressures. Prices edged up 0.4% year‑on‑year in April 2018, but inflation remains low due to reductions in public‑sector tariffs and various measures stimulating import competition, including cuts in customs duties.

Israel

1. Deflated by the private consumption deflator.

Source: Bank of Israel; and OECD Economic Outlook 103 database.

Statlink

Prudent fiscal policy must be maintained while promoting more inclusive growth

The Bank of Israel has kept its policy rate at 0.1% since March 2015. The shekel stopped appreciating in early 2018 and has stabilised in nominal effective terms around its average 2017 level. Despite these still accommodative monetary conditions, demand for housing has declined due in part to higher taxation of residential investment. This has resulted in a stabilisation in property prices in early 2018, as against an increase by 5.4% a year before, a trend which is likely to continue if monetary stimulus is withdrawn, as projected.

Israel. Demand, output and prices

Statlink

With a budget deficit target set at 2.9% of GDP in 2018 and 2019, up from an outcome of 2.1% of GDP in 2017, fiscal policy will support activity. This fiscal loosening, which results from increased spending in the social, education and health spheres, could be even more pronounced if new tax cuts mooted by the authorities are introduced. Yet, Israel must preserve ample fiscal margins, given heightened regional geopolitical tensions, and avoid pro‑cyclical injections of extra spending power, which weaken its public accounts, while the economy is at full employment. In such an environment, reforms that improve the training of disadvantaged groups, especially in the Israeli‑Arab and Ultra‑Orthodox communities, the functioning of product markets and public transport infrastructure should be favoured to strengthen both supply conditions and social cohesion.

Growth should strengthen

With a favourable external context and expansionary macroeconomic policies, growth is projected to accelerate to over 3½ per cent in 2018 and 2019. Low unemployment will continue to spur wages and household consumption. In addition, capital spending will be underpinned by planned investments in the high‑tech sector and the development of new offshore gas fields in 2019. Due to higher wage increases, inflation is expected to reach 1¾ per cent by the end of 2019. A deterioration of the already tense geopolitical situation or the external environment would, however, weaken these projections. Conversely, the economy could be stronger, and even overheat, if demand, supported by a better‑than‑expected global environment, is more robust and the central bank is slow to withdraw stimulus or the government follows through with tax cuts.