Good afternoon.
We are at the beginning of a new year. The year 2024 that just ended was full of security-related and economic challenges, and Israel’s economy continues to display its resilience. We have dealt with, and continue to deal with, as a state and as a society, the Swords of Iron War, and its broad impacts that are still leaving a notable imprint on all areas of our lives. The complex security situation and its effects on the economy are always among our considerations and are taken into account when reaching monetary policy decisions.
Yesterday and today, the Monetary Committee held discussions in order to reach the policy decision. At the end of the meetings, the Monetary Committee decided to leave the interest rate unchanged at 4.5 percent.
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The Monetary Committee’s discussions focused on the state of the economy and on an analysis of the various economic developments and the war’s effects on the economy.
The state of the Israeli economy is improving. However, the effect of the war, the uncertainty, and the various challenges are still with us. The inflation rate is above the target and is expected to continue to rise in the first half of the year, among other things against the background of the tax increases, and is expected to moderate in the second half. At the beginning of the war, there were notable supply limitations, which are gradually moderating. In parallel, in the past few months a recovery can be seen on the demand side. The alignment of aggregate supply and demand plays a significant role in creating conditions for price stability and moderation of inflation. The future development of supply, demand, and their equilibrium, adds uncertainty to the monetary policy. The economy’s risk premium has declined. This is, among other things, against the background of geopolitical developments, the ceasefire in the North, the declining intensity of the fighting, approval of the budget by the government, and of the package of taxation measures by the Knesset, which have led to the markets’ improved confidence in the Israeli economy. However, the risk premium remains high compared to its prewar level. In view of all these, the Monetary Committee continues to implement a cautious monetary policy, reflecting the need to deal with the continued geopolitical and economic uncertainty. This decision derives from the Committee’s assessment that the balance of inflation risks tends to the upside.
I will now review in greater detail the main considerations that we took into account when reaching the decision, and I will expand on the main economic developments in Israel and worldwide.
Inflation over the past 12 months has stabilized, and is 3.4 percent, above the upper bound of the target range. Looking forward, the inflation rate is expected to increase during the first quarter of the year to approximately 4 percent, among other things in view of the expected tax increases, and to moderate toward the target only in the second half of the year. The development of the inflation environment, economic activity, and geopolitical and fiscal risks will be a major component in determining the policy path going forward.
An analysis of real economic activity indicates that in the last quarter of 2024, the trend of recovery in activity continued, but GDP remains lower than the long term trend, particularly when netting out the impact of bringing vehicle imports forward.
In November and December, there was an increase in credit card expenditures and improvement in the net balance of the Business Tendency Surveys. Funds raised by high tech companies in the last quarter were above the average just before the war, and tax revenues remained stable at a high level. In contrast, the Composite State of the Economy Index for November remained unchanged, similar to the September and October indices, and the Purchasing Managers Index is still below the trend line.
The labor market remains tight. The employment rate and the participation rate increased slightly, and the number of job vacancies remained high relative to its level in the summer, as did the ratio of number of job vacancies to the number of unemployed. Although supply limitations in the labor market, derived mainly from the lack of non-Israeli workers and people absent due to military reserves service, are moderating gradually, they continue to weigh on economic activity. Despite the tight labor market, the real wage has not increased noticeably in the past year.
Construction industry activity recovered slightly in the third quarter of the year, but its level remains low relative to just before the war, and is impacted mainly by labor force constraints, which are still considerable. Third-quarter data from the Central Bureau of Statistics indicate that there has been an increase relative to the previous quarter with regard to data on building starts, building completions, and the number of permits granted. However, compared to the parallel quarter of the previous year—before the war—there has been a decline. In parallel, the upward trend in home prices continued, with an increase of 6.7 percent in the past year. Mortgage volume in November was high, at NIS 8 billion. A high level of construction supply over time, beyond its current level, will help to stabilize housing prices.
Since the previous monetary policy decision, the shekel strengthened by 0.5 percent against the dollar and by 2.4 percent against the euro. The risk premium as measured by CDS and government bond spreads declined markedly, but is still at a level higher than its prewar level. Israel’s equity market had a stellar year, with increases in the major equity indices, and its performance was notably strong compared to leading markets worldwide.
These issues, and others, are taken into account in the updated macroeconomic forecast published today by the Research Department. Similar to previous forecasts, this forecast too is marked by a particularly high level of uncertainty. However, the geopolitical developments since the October forecast reduced, in the Department’s assessment, the downside risks to the growth forecast.
The forecast was compiled under the assumption that the direct economic impact of the war will continue to the end of the first quarter of 2025. This assumption reflects a moderate level of intensity of fighting in the beginning of 2025 as well. 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 at first at a slightly more rapid pace. The forecast also takes into account the expected impact of budget adjustments on economic activity. Based on the Department’s assessment, GDP grew by 0.6 percent in 2024 and is expected to grow by 4.0 percent in 2025, slightly higher than in the October forecast. In 2026, the Department forecasts that GDP will grow by 4.5 percent.
According to the forecast, at the end of 2025 annual inflation will be 2.6 percent and in 2026 it will be 2.3 percent. The government budget deficit in 2024 is expected to be approximately 7 percent, slightly lower than the October forecast, due to a larger than expected increase in tax revenues in the last quarter, among other reasons due to the bringing forward of vehicle purchases, and slightly lower expenditures.
The deficit in 2025 is expected to be 4.7 percent of GDP, against the background of the changes in the adjustment measures since the government’s decision and our assessments regarding the supplements to the defense budget within the framework of the Nagel Committee. In 2026, the deficit is expected to be 3.2 percent of GDP, mainly due to the end of the war’s direct expenses. 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.
From the beginning of the war, and throughout the budget process, I have emphasized that if the debt to GDP ratio has to increase during the war, it is very important to establish a policy mix that will lead to a decline in the debt path afterward. As we have already expressed, the budget framework that was approved by the government, with the adjustment measures that have already been approved by the Knesset, was a significant step that contributed to the markets’ confidence in the Israeli economy and to moderation in the risk premium.
With that, during the discussions on the budget, several civilian expenditures of a permanent nature were added, and several adjustments of a permanent nature were removed or reduced. Therefore, it is important that the budget framework for 2025 will be approved without additional changes, which will contribute to maintaining the markets’ trust. Additionally, against every change in budget items that increases the deficit after 2025, it is important to adopt alternate measures that will prevent the growth of the expected deficits. In this way, the economy will be able to converge to a declining path of the debt to GDP ratio from 2026 and onward. In addition, it is important that to the extent the government approves an increase of the security budget from 2026 and onward on the basis of Nagel Committee recommendations, it will be accompanied by offsetting measures that will ensure a significant prolonged declining path of the debt to GDP ratio.
With regard to the budget’s composition, as we said when it was being compiled, it would have been better to integrate more growth-supporting components for the long and short terms, with an emphasis on removing barriers, and in particular to reduce expenditures that create negative incentives to entering the labor market and to increasing productivity. In addition, at time when the public has to bear the burden of painful steps, it would have been proper for the government to reduce the number of ministries and to make a substantial contraction in coalition funds that do not support growth.
Against the background of the war, it appears that in the coming years there will be a need to increase the manpower in the armed forces. This development impacts on the economy’s robustness. To deal with this increased burden, I reiterate the importance of broadening the circle of those serving in army. Beyond the social and values-related significance, the current situation in which large parts of ultra-Orthodox society do not serve in the military has a significant economic cost. We have said in the past that the increase in the burden of military service, when it falls mainly on those currently serving, will have a cost of approximately 0.5 percent of GDP per year, which is approximately NIS 10 billion per year. In order for the Draft Law to be effective, it will have to include recruiting levels that are in line with the army’s needs at that time, and personal negative incentives—economic and otherwise—for those not being recruited. Beyond that, widening the circle of those serving is likely, with a not-insignificant probability, to contribute as well to their integration into the labor market, an increase in their wages, and a contraction of economic gaps.
There is an additional point that is important to emphasize: in this period, which also serves as a test of the Israeli economy’s resilience, it is essential not to add more challenges and components that add to the uncertainty through constitutional changes, without broad agreement. In this regard, I have said in the past and I say it again, it is necessary to maintain the independence and strength of the institutions. This is part of the country’s economic resilience and a condition for the markets’ trust and sustainable growth.
Israel, as a small open economy, is markedly impacted by the global economy. Worldwide, economic activity continues to expand. The Global Purchasing Managers Index for November increased and is indicating continued expansion of economic activity. World trade in commodities is growing at a moderate pace and expanded in annual terms of about 1.6 percent in October. Economic growth data for the third quarter of the year showed trends of expansion in the US and in the eurozone. In the US, the CPI increased in November by 0.3 percent, to an annual pace of 2.7 percent, and the core index remains sticky. In the eurozone, the inflation rate increased to above the target, reaching 2.2 percent. The Fed, as expected, reduced the interest rate again by 25 basis points, but the interest rate path priced in by the markets increased in the reviewed period, against the background of a higher interest rate forecast. The ECB also continued on the path of reducing the interest rate, lowering it by 25 basis points, in line with forecasts, and it is expected to continue reducing the interest rate at a relatively rapid rate.
To conclude, the state of the Israeli economy is improving, but uncertainty remains high, and the various challenges are still with us. The Monetary Committee’s decision reflects its commitment to price stability and to strengthening economic robustness, by dealing with the geopolitical and economic uncertainty. The Bank of Israel will continue to act cautiously, to closely follow developments in the economy and in the inflation rate, and to base its decisions on a comprehensive analysis of the data.
The Bank of Israel and the Monetary Committee express our support and appreciation for the soldiers and other security forces who are risking their lives for us on the various fronts. We extend our deep condolences to the families of those killed. We also send wishes for a rapid and complete recovery for the injured, and hope for the speedy return of all the captives and the missing.
Our thoughts are with you.