Monetary policy: The Monetary Committee kept the interest rate unchanged at 4.5 percent in all its decisions in the second half of 2024. In view of the continuing war, the Monetary Committee’s policy is focusing on stabilizing the markets and reducing uncertainty, alongside price stability and supporting economic activity. The interest rate path was determined in accordance with the convergence of inflation to its target, continued stability in the financial markets, economic activity, and fiscal policy.
Domestic real activity and the labor market: In the second half of 2024, there was some increase in activity with a recovery of private consumption. After GDP growth in annual terms of 0.1 percent in the second quarter, GDP expanded by 3.8 percent in annual terms in the third quarter. However, its level remained about 3.6 percent lower than its long term trend. A considerable part of the gap is explained by supply constraints deriving from a shortage of workers—a shortage of non-Israeli workers, the absence of workers who are serving in the military reserves, and in part of the half year, by a limitation on employment in the North. The labor market remains tight, with a low unemployment rate and a nominal wage that increased in the half year at a moderate pace.
The inflation environment: At the end of the second half of 2024, the annual inflation rate was 3.4 percent, compared to 2.9 percent at the end of the previous half year. In the third quarter of 2024, the inflation rate increased, with a broad rise in prices of tradable and nontradable components, while in the fourth quarter of 2024 it stabilized. One-year inflation expectations from the various sources remained relatively stable around the upper bound of the target range during most of the half year, and moderated toward the end. However, inflation is expected to increase over the first half of 2025 in view of the changes in taxes, particularly the VAT increase, alongside continued supply constraints, together with excess demand—and is expected to moderate to within the target range in the second half of the year.
The exchange rate and financial markets: During the second half of 2024, the financial market trading remained volatile, impacted mainly by geopolitical developments. The shekel weakened at the beginning of the period, but later on it strengthened. Similarly, the economy’s risk premium increased markedly at the beginning of the period, but toward the end it declined notably—as measured by the CDS and government bond spreads. However, the risk premium remains high relative to the prewar period. The Israeli capital market had a positive year with increases in major equity indices, and was notable compared to leading markets worldwide. In the period reviewed, the Moody’s (in September) and S&P (in October) rating agencies again lowered Israel’s credit rating and added a negative rating outlook.
Fiscal policy: During the second half of 2024, the deficit target for 2024 was set at 7.7 percent of GDP, and for 2025 at 4.4 percent of GDP, with the allocation of a special reserve supplement of half a percent of GDP that may be used in case there is continued high intensity of fighting. However, the Research Department’s forecast is that the deficit in 2025 is expected to be 4.7 percent of GDP. This is against the background of changes in the adjustment measures since the government decision and assessments regarding the supplements that will be given to the defense budget within the framework of the Nagel Committee. In 2026, the deficit is forecast to be 3.2 percent of GDP, mainly due to a decrease in the defense expenditure burden. The debt to GDP ratio is expected to increase to a level of 67 percent in 2024, to 69 percent in 2025, and to decline back to 67 percent in 2026. The Monetary Committee discussions also noted that the budget framework approved by the government with the adjustment measures approved by the Knesset were significant steps that contributed to the markets’ confidence in the Israeli economy and led to moderation of its risk premium. However, it is important that the budget framework for 2025 will be approved without additional changes, and that a declining path of the debt to GDP ratio will be adopted beginning in 2026. These steps will contribute to maintaining the markets’ confidence and the economy’s resilience.
The housing market: Activity in the construction industry is recovering gradually, but there are still considerable limitations, mainly workforce constraints, on activity due to the war. Home prices continued to increase during the reviewed half year, and the pace of annual increase remains high, at 6.7 percent (though September-October). The rate of increase of the housing component in the CPI was 4.1 percent at the end of the half year reviewed. Central Bureau of Statistics third quarter data show an increase compared to the previous quarter in building starts, building completions, and number of permits granted. However, compared to the corresponding quarter of last year, before the war—there was a decline. The Committee members reiterated the importance of maintaining a high stock of construction supply over time, above its current level, to support the stabilization of housing prices.
The global economy: Economic activity in the US remained robust, driven by personal consumption. In the eurozone, third quarter growth surprised to the upside, but looking forward the recovery in the eurozone is expected to remain moderate. Third quarter growth in China surprised to the upside as well, but the most recent data are still relatively weak. Inflation trends worldwide showed moderation in the reviewed period, but in the US the inflation rate remains stickier. In the reviewed period, the US Federal Reserve began a round of interest rate reductions that totaled one percentage point, but at the end of the period the expected interest rate path rose. The ECB continued its round of interest rate reductions.
The Research Department forecast: The Research Department updated its macroeconomic forecast during the period. The Research Department forecast that was published in January 2025 was compiled under the assumption that the direct economic effect of the war will continue at a moderate level of intensity until the end of the first quarter of 2025. The Department assumes that during the period of the forecast, the existing limitations on the supply side will gradually recede, and domestic demand will recover first at a pace slightly more rapid than that of supply. The forecast also considered the expected impact of the budget adjustments on economic activity. In the Department’s assessment, geopolitical developments since the October forecast reduced the risks to the downside in the growth forecast. According to the Department’s forecast, GDP grew by 0.6 percent in 2024, and will grow by 4.0 percent in 2025, and by 4.5 percent in 2026. According to the forecast, the annual inflation rate at the end of 2025 will be 2.6 percent and will be 2.3 percent in 2026.