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Good afternoon.
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 lower the interest rate to 3.5 percent
Since the previous interest rate decision, there have been notable geopolitical developments, which affected domestic and local markets. The Memorandum of Understanding (MOU) signed between the US and Iran led to a decline in energy prices and moderation in global geopolitical tension. However, the level of uncertainty remains high. In parallel, the governments of Israel and Lebanon signed an MOU, but tension continues in the North, and its ramifications continue to be reflected in economic activity.
The Committee’s discussions focused on the state of the economy, an analysis of local and global economic processes, and the impacts of the geopolitical uncertainty on the economy. In recent months, the inflation rate has remained near the midpoint of the target range, and data on economic activity indicate continued recovery. For the reviewed period overall, the shekel depreciated, with considerable volatility.
I will now go into deeper detail about our main considerations when reaching the decision, and I will expand on the main economic developments in Israel and abroad.
The inflation rate over the preceding 12 months was 1.9 percent in April and in May, at the midpoint of the target range. Based on forecasters’ assessments, it is expected to decline in the coming months, and to be around the midpoint of the target range in a year.
Looking ahead, there are several factors that can affect inflation’s development in opposing directions. The inflation environment will be impacted markedly by the geopolitical developments and their effects on economic activity and on energy prices, the risk premium and exchange rate, the development of demand alongside supply constraints, and by fiscal developments. At this time, the magnitude of the impact of these factors over various time ranges is uncertain.
Economic activity continues to recover gradually, against the backdrop of domestic and global uncertainty. Credit card expenditures are slightly above their long term trend line. The aggregate balance of the Business Tendency Survey conducted by the Central Bureau of Statistics for May increased, following the sharp decline in the wake of Operation Roaring Lion against Iran, although it has not yet returned to its level before the operation. Capital raised in the high tech sector in the second quarter of the year amounted to approximately $4 billion, a level similar to that of the first quarter of the year, but lower than in the final two quarters of 2025.
Analyses conducted by the Research Department indicate that a marked share of recent economic growth reflects production abroad by global firms operating in Israel. In contrast, other parts of the economy, particularly labor-intensive industries, have been more materially affected by the supply constraints that emerged during the war. In the Research Department’s updated forecast, on which I will elaborate later, these supply constraints are expected to moderate over time, with growth becoming more broadly based across a wider range of industries and companies in the economy, and converging toward the long-term trend line.
The labor market remains tight, although some easing is evident in the labor supply constraint, with a decline in the share of workers temporarily absent from work due to military reserve service. The broad unemployment rate among the prime working ages (25–64) declined. The labor force participation rate for ages 15+ has been declining for several months and remains below its level on the eve of October 7th, with the decline more pronounced among younger age groups. At the same time, among the prime working ages (25–64), both the employment rate and the participation rate have remained stable. Wages are rising at a relatively rapid pace, reflecting a tight labor market. The pace of wage growth in the economy in March-May stood at 6.8 percent compared to the corresponding period a year earlier. The increase in wages reflects, inter alia, increases in the minimum wage and in public sector wages. The pace of wage growth in the business sector rose in February–April and stood at 6.4 percent compared to the corresponding period a year earlier. At the same time, the data were affected by changes in workforce composition stemming from Operation Roaring Lion.
Construction industry activity remains strong. The pace of building starts is high, building completions continue to increase, and building permits remain at a high level. The stock of homes that remain for sale continues to be high. In May, home prices continued to decline, at an annual pace of 1.3 percent. As I have noted numerous times, it is important to continue maintaining a high level of supply. In the CPI for May, the pace of increase of the housing component increased to 4 percent. The annual growth rate in renewing leases was 2.5 percent, and the annual rate of increase in leases with a turnover of tenants accelerated to 6.8 percent in the May CPI.
In the financial markets, since the previous monetary policy decision, the shekel depreciated by 3.1 percent against the dollar and by 1.5 percent against the euro. This occurred with volatility during the period, following a marked appreciation at its outset. Israel’s risk premium, as measured by CDS spreads, remained close to its level prior to October 7th. Domestic equity indices declined over the reviewed period and underperformed relative to global markets, following a period of outperformance over the previous two years.
As reflected in the tradable components of the CPI, appreciation also has a moderating effect on inflation through the pass-through to prices of imported goods. To strengthen this pass-through and its impact on the cost of living, competition in the retail and wholesale sectors should be enhanced. At the same time, the sharp appreciation of the shekel in the recent period poses significant challenges for the export and high tech sectors, which are key growth drivers of the Israeli economy. Against this backdrop, the measures announced by the Ministry of Finance, in line with the Bank of Israel’s recommendations, should assist firms in the short term and in a targeted manner in adjusting to the changing price environment, while supporting the continuation of their operations and investment in Israel. Over the longer term, maintaining competitiveness will continue to depend primarily on productivity growth, innovation, and the business sector’s ability to adapt to changing market conditions. In parallel, increasing the economy’s exposure to competition, including by reducing import barriers, could also help narrow the surplus in the goods and services account and moderate appreciation pressures on the shekel.
The Research Department has updated its macroeconomic forecast. The baseline assumption underlying the forecast is that there will be no renewed round of hostilities with Iran over the forecast horizon. In addition, the forecast assumes that the intensity of the fighting in Lebanon will decline, contributing to some easing of supply constraints in the economy. In addition, the forecast assumes that global energy prices will remain around the lower levels reached following the agreement.
According to the Department’s assessment under this scenario, GDP is expected to grow by 4 percent in 2026, slightly higher than in the March forecast. In 2027, GDP is projected to grow by 5.5 percent. Inflation during 2026 and 2027 is expected to be 1.8 percent. The forecast assumes that the defense budget will be increased by NIS 15 billion, mainly through accessing a buffer amounting to approximately NIS 13 billion that was allocated in the budget. Under this assumption, the government budget deficit is expected to amount to 4.9 percent of GDP in 2026 and 4.2 percent in 2027. The debt to GDP ratio is projected to stand at about 69 percent at the end of 2026 and at the end of 2027. The Department projects that the interest rate will be 3 percent in one year’s time.
There is high uncertainty around the forecast related to the geopolitical developments in the region and their impact on the economy. The government is considering the possibility of increasing the defense budget for 2026 by up to an additional NIS 25 billion over the course of the year, so that the budget will be NIS 183 billion. To the extent that this occurs, the deficit is expected to be higher than the forecast, at 5.5 percent of GDP, with inflation for the year ahead higher than forecast by 0.3 percent, in line with the expenditure composition and its impact on the supply constraint.
As I have said in the past, the economy is facing what I have termed a “fiscal trilemma”—the challenge of putting the debt to GDP ratio on a declining path while financing defense expenditure and investing in growth drivers. Any government that is formed will need, in the context of the 2027 budget, to address this challenge. Returning the debt to GDP ratio to a downward trajectory and rebuilding fiscal buffers that will strengthen the economy’s resilience to future shocks, are important goals. One of the key lessons of recent years is that fiscal buffers are not a luxury but a strategic asset. The fact that Israel entered both the COVID-19 crisis and the war that broke out on October 7th with a debt to GDP ratio of around 60 percent, and consequently with relatively low interest payments as a share of GDP, gave the government significant room for maneuver in responding to these crises. Globally, and particularly in our region, economic and security shocks are not exceptional events; it is therefore important to act in a manner that ensures the preservation of fiscal buffers.
In this context, an increase in defense spending relative to the level that prevailed on the eve of the war is expected to remain with us in the coming years, making the fiscal trilemma even more challenging. Achieving these objectives is likely to require, in the 2027 budget, fiscal measures that increase the revenues available to the government. This will be necessary even alongside more efficient use of public expenditure, in particular through reducing expenditures that create negative incentives for labor force participation and productivity growth. The more population groups that join the labor market, the smaller the tax burden required to raise government revenues will be.
Geopolitical developments worldwide continued to be at the center of attention during the reviewed period, as an MOU was signed between the US and Iran. However, geopolitical uncertainty has not dissipated entirely, as a number of issues remain unresolved. The MOU led to a sharp decline in oil prices, and by the end of the period the price of Brent crude was trading at a level similar to that prevailing prior to the confrontation. Accordingly, inflation expectations in the US and in Europe declined sharply,
In the United States, the Federal Reserve left its policy rate unchanged, while the European Central Bank (ECB) raised its policy rate by 25 basis points for the first time since September 2023. In the United States, the interest rate path incorporates reflects one and a half interest rate increases over the course of a year, and in Europe the path reflects one other interest rate increase in the course of a year.
In conclusion, we are still in an environment of high geopolitical and fiscal uncertainty and the range of scenarios remains wide. Developments since the previous interest rate decision support some moderation in the inflation environment and in continued recovery of economic activity. This is in view of the reduction of energy prices, the easing in supply constraints, and the decline in Israel’s risk premium.
As I have already said, to the extent that inflation expectations decline, and especially if they approach the lower bound of the target range, it will justify more accommodative monetary policy, and at faster paces. The Monetary Committee will continue to act in accordance with data and in line with updated economic developments. The interest rate path will be determined in accordance with inflation developments, economic activity, geopolitical uncertainty, and fiscal developments.
The Bank of Israel and the Monetary Committee continue to express our support and appreciation for the soldiers and other security forces who are fighting bravely for us on the various fronts. We extend our sympathies to the families of those who have fallen, and wish a rapid and complete recovery for the injured.
Thank you.