Bank of Israel Annual Report 2024
Governor's Letter
Contents
Chapter 1 - The Economy and Economic Policy During the War
- The war had a significant impact on economic activity this year, primarily due to supply constraints, most notably a shortage of workers. GDP increased by only 0.9 percent compared to 2023, and business output contracted by 0.8 percent.
- Despite a partial recovery due to a decrease in the war’s intensity during the year, GDP and most of its components remained lower throughout the year than they were before the war.
- The global environment was relatively favorable in terms of demand, as reflected in global GDP growth and increased world trade. Inflation in the advanced economies moderated, and central banks reduced interest rates.
- The easing of supply constraints was only gradual during the year, mainly due to the continued prohibition on the entry of Palestinian workers and the absence of many reservists and residents of conflict areas from their regular workplaces.
- The government’s main fiscal policy dilemma was balancing the immediate needs of the war with maintaining the credibility of its commitment to a sustainable fiscal path. Therefore, the government financed the ongoing war expenses by increasing public debt, which soared to about 68 percent of GDP, and implemented restrictive fiscal measures, mostly in the 2025 budget, to offset the expected permanent increase in expenditures due to the war.
- Annual inflation totaled 3.2 percent, slightly higher than in 2023, in view of a gradual recovery in demand alongside persistent supply constraints. This was contrary to the global trend of moderating inflation.
- The Bank of Israel lowered the interest rate by 0.25 percentage points at the beginning of the year, following the stabilization of the financial markets, moderation of the inflation environment, and reduced war intensity compared to the beginning of the war.
- The Bank of Israel’s interest rate remained at 4.5 percent throughout 2024, in order to continue supporting market stability in view of the ongoing war and to bring inflation, which had risen, back to the target range amid dominant supply constraints.
- The labor market was tight due to the supply constraint on workers, alongside increased demand supported by the sharp rise in government expenditures. As a result, nominal wages rose rapidly, as did the unit labor cost.
- The construction industry faced a particularly severe shortage of workers, leading to extended construction times, a slowdown in building completions, and increased financing costs for contractors. These issues gradually and partially eased. Housing demand declined at the beginning of the war but recovered later, with the number of transactions and mortgage volumes increasing, accompanied by rising home prices.
- The economy’s risk premium rose significantly at the beginning of the war and was characterized by volatility and a moderate upward trend for most of the year, mainly due to increased geopolitical risk, accompanied by a significant rise in the debt-to-GDP ratio.
- Toward the end of the year, in view of the ceasefire in the north and assessments that security risks had decreased, there was a turnaround in the markets. The shekel appreciated, local stock prices soared, the economy’s risk premium decreased significantly—though it remained higher than before the war—and the yield on government bonds, which had surged at the beginning of the war, returned to its prewar level. These positive developments were also supported by significant fiscal measures to reduce the deficit, which the government approved at the end of 2024.
- Due to the war and its expected long-term effects on the growth of public expenditure, the challenge of addressing the economy’s fundamental problems—such as low labor productivity and high poverty rates—through increased public investment in human capital and infrastructure has intensified. Additionally, the economic necessity of quickly integrating additional population groups into the labor market and sharing the burden of military service has become more pronounced.
Chapter 2 - GDP and Employment
- The developments in the Swords of Iron War have significantly impacted economic activity this year, leading to a reduction in production capacity, primarily due to a decrease in labor supply. Business sector product contracted by 0.8 percent, further to the very low growth from last year. Total GDP grew by 0.9 percent, and per capita GDP declined slightly.
- The rapid increase in public consumption created excess demand in the economy—both due to the mobilization of a significant number of reservists, which reduced the production capacity of the business sector, and due to the influx of demand for goods and services produced by the business sector.
- Observing the development of the mix of uses throughout the year, there is a gradual return to the mix characteristic of routine times: a decrease in public sector demand and a recovery in private consumption and investments.
- The prohibition on Palestinian workers entering Israel reduced the labor supply in the business sector by 3.4 percent, and the transition of personnel to reserve service reduced it by about 1.5 percent. These factors limited production capacity in the economy and also resulted in a low unemployment rate.
- The economy was close to its maximum production capacity given the labor supply constraints, thanks to the resilience of domestic demand.
- Startup company output sharply declined this year, contributing about 0.8 percent of GDP to the overall decrease in activity. This decline mainly reflects the global decrease in demand for investments in startup companies since mid-2022.
- Private consumption growth slowed moderately relative to routine periods, with its average level this year being 1.7 percent higher than in the first three quarters of 2023. This slowdown was driven by decreases in outbound tourism and in service consumption. However, consumption recovered over the course of the year, such that in the last quarter of 2024, private consumption was 5.6 percent higher (4.8 percent in annual terms) than before the war.
- Exports declined this year, even excluding tourism services exports, despite the increase in global trade. This can be explained by the reduction in production capacity due to labor constraints, difficulties in closing export deals due to the state of war, and a decrease in global demand for products and services in which Israel specializes.
- Fixed capital formation was, on average, 12.7 percent lower this year than in 2023 before the conflict. This was mainly due to a decrease in construction investment—resulting from the prohibition of Palestinian workers and the slow pace of foreign workers arriving to replace them.
Chapter 3 - Inflation and Monetary Policy
- In 2024, the annual inflation rate stood at 3.2 percent, slightly above the upper limit of the target range. Inflation accelerated in the second and third quarters of the year and moderated towards its end. Expectations remained anchored within the target range for most of the year.
- Price developments were influenced by the war and its extended duration, which caused prolonged supply constraints, while demand constraints declined during the year, partly due to the government’s significant expenditures driven by the economy’s wartime needs.
- Throughout the year, in view of the continuing war, monetary policy focused on maintaining the stability of the financial markets, utilizing a variety of policy tools and targeted measures, while returning inflation to the target range and supporting economic activity.
- In view of the moderation of inflation at the end of 2023 and the expectations for its continued moderation, the Monetary Committee lowered the interest rate in January to 4.5 percent. At that time, expectations were that the interest rate would continue to decline during the year.
- Later in the year, the committee left the interest rate unchanged, noting in its decisions that the policy path would be data dependent. The committee’s assessment was that the current and expected interest rate environment would lead to the restraining of inflation without hindering economic recovery.
- At the onset of the war, there was an increase in the country’s risk premium, as reflected in the yield spreads on government bonds and the CDS premium. Toward the end of the year, these indices declined significantly, but their levels remained higher than before the outbreak of the war.
- The exchange rate of the shekel was largely affected by geopolitical developments and the risk premium. Despite the increase in the country’s risk premium due to the war, the shekel was appreciated at the end of 2024 compared to its level before the war.
- Contrary to developments in Israel, inflation in most developed countries moved toward the target in 2024, after having been high in the previous two years. Accordingly, central banks in these countries began to lower interest rates.
Chapter 4 - Development of financing sources for the nonfinancial private sector
- Amid its resilience and stability, the financial system continued this year to support economic activity and the recovery of the economy, despite the complex challenges facing the Israeli economy.
- The private debt-to-GDP ratio increased slightly this year, both in the business sector and among households, but remains low by international standards.
- Corporate bond spreads in the business sector decreased to levels lower than those before the war, similar to the global trend.
- Construction companies increased their use of bank financing and bonds to support ongoing activities and compensate for the decline in cash flows from developers, particularly in the first quarter of the year.
- Outstanding household credit grew by 6.6 percent this year, higher than the 2.3 percent growth in 2023, driven by housing credit.
- The volume of new mortgages grew by approximately 30 percent this year, with increased use of “bullet” loans as part of contractors’ financing campaigns, and a rise in the risk indices of mortgages.
- The growth in the public’s asset portfolio was higher this year than in previous years. There were significant increases across all components, notably in equities and bonds, both domestic and international.
Chapter 5 - The Labor Market
- In 2024, the labor market was affected by the ongoing consequences of the Swords of Iron War. The impact was primarily concentrated on the labor supply, which contracted significantly at the beginning of the war and remained low until the end of the year.
- The main factors contributing to the weakness of the labor supply in 2024 included a decrease in the number of non-Israeli workers, extensive military reserve call-ups, the evacuation of residents from conflict zones, and casualties of the war.
- The supply of non-Israeli workers dropped sharply compared to prewar levels, significantly affecting industries that rely on these workers. By the end of 2024, their numbers were about one-third lower than before the war.
- Labor force participation rates declined across all demographic groups, but the contraction was particularly pronounced among military-age men and young women.
- The number of employed Israelis increased moderately. Employment increased in the public sector (excluding regular and reserve military service) and declined in the business sector.
- Constraints on labor supply alongside high demand for workers were reflected in low unemployment, indicating a tight labor market. Real wages increased in the business sector, while remaining largely unchanged in the public sector (excluding regular and reserve military service).
- The trend of adopting generative artificial intelligence technologies strengthened this year in the Israeli economy, as part of a global trend. This process is expected to bring about significant changes in the labor market in the coming years. To prepare the labor market for these changes, it is important to promote policies that enable affected workers to adapt.
Chapter 6 - The Public Sector and Its Financing
- The Swords of Iron War has led to a significant increase in government expenditures for both security and civilian needs. The 2024 budget was revised three times to accommodate additional funding, amounting to approximately 5 percent of GDP, primarily to cover war-related costs.
- The growth in tax revenues compared to the previous year aligned with the increase in nominal GDP, which largely reflected the increased government activity.
- This year, the budget deficit was 6.8 percent of GDP, slightly above the expectations set during the approval of the revised budget in March 2024. The general government deficit reached 9.4 percent of GDP.
- At the end of 2024, the debt-to-GDP ratio was 67.8 percent, a sharp rise from 61.5 percent at the end of 2023.
- The government implemented significant convergence measures, effective at the beginning of 2025, which are sufficient to offset most of the permanent spending increases resulting from the war’s impact.
- Despite these adjustment measures, the government’s structural deficit (approximately 3.6 percent) is higher than the level required to reduce the debt-to-GDP ratio (around 3 percent). This is because, beyond the spending increase due to the war’s medium-term effects, the government also raised other permanent expenditures.
- The rise in defense spending and interest payments due to the war reversed their long-standing downward trend, which had allowed for an increase in civilian spending over the past two decades without raising taxes and/or increasing the debt-to-GDP ratio.
- Given the structural risks and challenges facing the economy, a clear policy trajectory for the gradual reduction of the debt-to-GDP ratio over time is necessary in order to create renewed fiscal space while addressing the heightened security needs and promoting sustainable growth.
- Public spending on infrastructure and education is low by international standards, considering development needs and demographic trends.
Chapter 7
Chapter 8 - The Housing Market
- The construction industry experienced a shortage of labor and a decline in building activity this year due to the prohibition on the entry of Palestinian workers following the outbreak of the war. This primarily resulted in extended construction timelines, a decline in building completions, and a more serious impact to nonresidential construction starts.
- The volume of residential real estate transactions increased this year, accompanied by a 7.3 percent rise in home prices and an increase in the inventory of unsold homes. This is likely due to concerns about limited future supply due to the current decline in the volume of construction, and the need to repair war damages.
- The increased demand for new homes drove the increase in transaction volume, further boosted by financing offers from developers.
- Despite the challenges posed by the war, planning authorities approved 204,000 housing units, some as part of rehabilitation plans for the south and north. However, transitioning from approval to execution in some of these plans requires overcoming significant obstacles.
- The number of housing units marketed by the Israel Land Authority through tenders with winners and without tenders remained stable compared to 2023, but compared to 2021 and 2022, there was a reduction alongside a decrease in land prices.
- The government initiated “mega umbrella agreements” to accelerate the increase in housing supply. The new model sets a high bar for the scope of agreements and the pace of implementation, but infrastructure challenges in transportation and water, which already delay the implementation of regular umbrella agreements, may also pose obstacles for the “mega” agreements.
- The evacuation of localities from the south and north reduced the effective housing stock and increased demand for housing services in other areas. In contrast, the availability of hotel rooms, which helped accommodate evacuees, a negative migration balance, and a high rate of young people serving in the reserves moderated the demand for housing services. Rental prices increased by 4.0 percent.
- The shortage of non-Israeli workers in the industry since the outbreak of the war underscores the importance of improving the workforce by enhancing workers’ readiness to adopt industrialization, which will compensate for the labor shortage.
Full Report 2024