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- Economic activity and the labor market continue to recover gradually. Alongside this, the extent of geopolitical uncertainty has increased, reflecting a relatively high risk premium for the economy.
- Inflation in the past 12 months has moderated, and is within the target range. Expectations and forecasts for the coming year increased slightly, and are around the upper bound of the target range.
- Since the previous monetary policy decision, the shekel weakened by about 2.7 percent against the US dollar, by about 2.6 percent against the euro, and by about 2.3 percent in terms of the nominal effective exchange rate.
- GDP contracted by 5.6 percent in the fourth quarter of 2023, compared with the third quarter. Over the year as a whole, GDP grew by 2 percent. The GDP growth was in line with the Research Department’s forecast from January 2024. The Research Department’s assessment is that GDP will grow by 2 percent in 2024 and by 5 percent in 2025. In view of the war, the forecast is characterized by a high level of uncertainty.
- In the housing market, home prices increased in the past two months. The housing component of the CPI declined by 0.3 percent, and the pace of annual increase continued to moderate, reaching 2.6 percent. The constraints and activity difficulties in the construction industry in view of the war have moderated, but remain significant.
- The pace of global economic activity was surprisingly good in view of stronger activity in the US, while the economic weakness in the eurozone continued. Inflation moderated in many countries, but in most it remains above the central bank targets. According to market assessments, these are expected to moderate the path of interest rate declines.
In view of the 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 will be determined in accordance with the continued convergence of inflation to its target, continued stability in the financial markets, economic activity, and fiscal policy.
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The State of Israel has been at war since October 7, 2023. Beyond the security effects of the war, it is having significant economic consequences, both on real activity and on the financial markets. Indicators of economic activity continue to point to a gradual improvement, following a significant contraction in business activity with the outbreak of the war. Geopolitical uncertainty has increased and is reflected in the economy’s relatively high risk premium.
The CPI increased by 0.4 percent in February, similar to expectations. Inflation in the past 12 months continued to moderate, and is within the target range, at 2.5 percent (Figure 1). Net of energy and fruits and vegetables, inflation in the past year moderated to 2.2 percent (Figure 2). The annual pace of inflation of the tradable components increased to 1.8 percent. The pace of annual inflation of the nontradable components of the CPI, which mainly reflects the housing services component and the services industries, is 3 percent (Figures 4). Inflation expectations from various sources for the coming year increased, and are around the upper bound of the target range (Figure 6). Expectations for the second year and onward are within the target range, in its upper portion, and incorporate the announced future tax increases (Figure 7). The Committee’s assessment is that there are still a number of risks of a potential acceleration in inflation: the development of the war and its effect on economic activity, a depreciation of the shekel, the constraints on activity in the construction industry, and fiscal developments, and the global price of oil.
Since the previous interest rate decision, the shekel weakened by about 2.7 percent against the US dollar, by about 2.6 percent against the euro, and by about 2.3 percent in terms of the nominal effective exchange rate (Figure 8).
The Bank of Israel Research Department revised its macroeconomic forecast, which based on the assumption that the war will remain concentrated on the southern front, and continue with declining intensity until the end of 2024. For 2025, the assumption is that the war will not have any further direct effects. The forecast features a particularly high level of uncertainty, partly with regard to the severity and duration of the war and with regard to developments in other areas. According to the forecast, and similar to earlier forecasts, GDP is expected to grow by 2 percent in 2024 and by 5 percent in 2025 (Figure 14). The broad unemployment rate[1] among the prime working ages (25–64) is expected to average 3.7 percent in 2024 and 3.3 percent 2025. Annual inflation in 2024 is expected to be 2.7 percent, and in 2025 it is expected to be 2.3 percent. The Research Department’s assessment is that the state budget deficit will be higher than in the previous forecast, and is expected to be 6.6 percent of GDP in 2024, and 4.6 percent of GDP in 2025. The debt-to-GDP ratio is expected to be about 67 percent at the end of 2024 and to remain at a similar level in 2025.
Indicators of economic activity and employment point to a continued gradual recovery following the sharp decline that took place with the outbreak of the war, but there is variance between industries. The expansion of activity has mainly been due to recovery of demand. Supply constraints remain high in a number of industries.
The level of activity as measured on the basis of rapid indicators for the first quarter of 2024 reflects a strong recovery, but activity remains lower than what it was prior to the war. The aggregate balance of the Central Bureau of Statistics Business Tendency Survey for March continues to indicate recovery, and businesses’ assessments of their situation are positive but remain lower than they were prior to the war (Figure 15). In addition, the share of companies in the services and manufacturing industries that reported a moderate or serious constraint to increasing activity due to a shortage of equipment and raw materials moderated, but remained higher than before the war. In the construction industry, the most recent data show an expansion of the scope of the equipment constraint, which is high (FIGURE 19). According to the survey, the restriction due to difficulty in hiring workers (moderate or severe) remains higher than before the war in most industries.
The recovery in the volume of credit card transactions continued in March, and total purchases remained slightly higher than the prewar average. However, there is variance between industries. The Composite State of the Economy Index for February increased by about 0.5 percent, further reflecting the gradual recovery of the economy. Foreign trade data indicate increases in goods imports and exports and also in services exports (Figures 21 and 22). Services exports (excluding startup companies) increased in January, following a downward trend that began at the beginning of the war. The increase in the most recent data was led by the export of business services, particularly high-tech services. The cumulative deficit in the past 12 months continued to increase in February, to 5.6 percent of GDP. Tax revenue in February was only 0.5 percent lower in real terms than in the same period last year, and came close to the multiyear trend.
The labor market continued to recover in view of the increase in demand for workers and an easing of the labor supply constraint due to the return of employees from military reserve service. The employment rate remains stable in February, at a level lower than before the war, and the employment rate net of those temporarily absent for economic reasons continued its upward trend. The broad unemployment rate[2] continued to moderate in February, to 4.4 percent compared with 4.8 percent in January. The rate of employees absent from their jobs for noneconomic reasons also moderated, and now reflects almost solely those performing reserve duty (1.5 percent). Labor input (the total number of actual work hours in the economy) continued its upward trend, but remained lower in February than the 2023 prewar average. The job vacancy rate declined slightly in February following a sharp increase in January (Figure 23). According to Central Bureau of Statistics flash surveys, the average wage per employee post continued to increase in February, and in the past three months, the annual rate of increase in the nominal wage was 8.3 (the past three months compared to the same period last year). This pace is still influenced by the composition of employees due to furloughs in the previous months and by one-off wage increments paid in January 2023. However, the effect of the change in the composition of employees dissipated in January and February, and the nominal wage level is consistent with the forecast based on the pace of increase from before the war. The most recent data also indicate that real wages are converging to the trend that existed between 2015 and 2019, prior to COVID-19 (Figure 24).
In the housing market, home prices increased in the past two months, alongside continued moderation in rents. Despite the supply constraints in the construction industry and the sharp decline in investment in residential construction, while building starts in the fourth quarter of 2023 declined, they remained high by long-term comparison, and building completions reached record highs. The index of home prices increased by 1.2 percent in December–January, and prices of new homes increased by 0.4 percent. However, in the past 12 months, home prices declined by a cumulative rate of 0.6 percent (Figure 11). The number of housing transactions in January was higher than in the same month last year. In March, new mortgage borrowing totaled about NIS 6.2 billion, higher than recent months (Figure 12). The owner-occupied housing services component of the CPI declined by 0.3 percent, and its annual rate of increase continued to moderate, to 2.6 percent. Alongside these figures, activity in the construction industry is recovering gradually, but the industry continues to function below its full potential. Supply constraints in the construction industry and the need for housing solutions for those evacuated from their homes due to the war may make it difficult for further moderation of housing and rental prices.
In the capital market, local equity indices rose. However, the cumulative underperformance of the domestic equities market relative to the global market since the start of 2023 remains significant (Figure 36). Long-term government bond yields increased during the reviewed period, by slightly more than the global trend. Corporate bond spreads, which widened at the start of the war, declined to below their prewar levels (Figure 10).
The Fitch international credit ratings agency kept Israel’s credit rating at A+, but changed its ratings outlook from stable to negative. The negative outlook, as explained by the agency, is mainly due to uncertainty regarding the expansion of the war to the northern front, the duration of the fighting in Gaza, and the change in fiscal policy. Israel’s risk premium as measured by the CDS is high, and increased in recent days in view of geopolitical tensions. The spread between dollar-denominated Israel government bonds and US Treasuries remained unchanged, at a high level.
In the credit market, the slowing trend of bank and nonbank credit continued. Risk indices in all activity segments increased, but their level is not excessive from a long-term perspective. According to the Central Bureau of Statistics Business Tendency Survey for January, the difficulty in obtaining credit continued to moderate among large and medium businesses, and increased someone in the most recent figures among small businesses following a decline in recent months (Figure 13).
The pace of global economic activity was surprisingly good in view of stronger activity in the US and some recovery in China. In contrast, the economic weakness in the eurozone continues, mainly in Germany. Investment houses revised their global growth forecasts slightly upward, mainly with regard to the US (Figure 29). The global manufacturing sector, which has suffered from weakness for many months, is showing signs of recovery. The global Purchasing Managers’ Index increased in March, and indicates continued expansion of activity.
World trade increased for the first time in a number of months. Oil prices increased significantly during the reviewed period, and shipping prices, which had jumped in view of the tension with the Houthis in the Red Sea, are moderating.
In the US, the general CPI increased in February to an annual rate of 3.2 percent, while the core PCE index moderated slightly to 3.8 percent. In the eurozone, inflation is moderating, and the general CPI declined to 2.4 percent in March. Core inflation is moderating as well, and stands at 2.9 percent. The inflation environment moderated in many countries, but remains above the central bank targets in most of them (Figure 33). Inflation in the price of services remains sticky and is making it difficult for inflation to converge to the targets. The Federal Reserve and the European Central Bank left their interest rates unchanged, and signaled that the downward path of the interest rate will be slower and more gradual in the future.
The minutes of the monetary discussions prior to this interest rate decision will be published on April 21, 2024. The next decision regarding the interest rate will be published at 16:00 on Monday, May 27, 2024.
[1] In addition to unemployed persons under the normal definition, the broad unemployment rate includes employees who are temporarily absent for economic reasons (including those put on furlough). The definition of broad unemployment does not include employees who were absent from their jobs for other reasons, such as reserve duty, caring for children in the absence of day care or educational frameworks, and others.
[2] See previous footnote.