OECD Economic Outlook, Volume 2026 Issue 1

Israel

Following the sharp contraction caused by the March-April 2026 military operations, the economy will rebound strongly. Resilient private-sector fundamentals, stable financial conditions, and rapid post-ceasefire recovery in consumption and construction are projected to result in GDP growing by 3.3% in 2026 and 5.6% in 2027. Inflation will ease from 2.3% in 2026 to 2.1% in 2027 as fuel prices abate and labour supply normalises. Fiscal deficits will narrow as defence spending declines and revenues remain solid. Risks are substantial on both sides: renewed high‑intensity warfare would weaken activity and worsen public finances, while deeper regional trade integration could deliver significantly stronger growth.

Monetary policy will have renewed scope for easing once security‑related labour constraints abate. Fiscal policy should rebuild buffers by sustaining revenue measures, reducing defence outlays when feasible, while preserving room for growth‑enhancing investment in education and infrastructure.

Conflicts hit a robustly growing economy

The wars with Iran and in Lebanon broke out in a period of rapid private-sector-led economic growth. Industrial production expanded at an annual rate of 11% in the three months to January 2026. Credit card purchases by households rose 9.2% year-on-year in February 2026. Unemployment narrowed from 3.2% of the labour force in December 2025 to 2.6% in February 2026, while inflation eased from 2.5% year-on-year in November-December 2025 to 1.9% in January-February 2026. The large-scale military operations and missile attacks over Israeli territory resulted in a sharp private-sector contraction in March 2026, as schools closed and many workers shifted from civilian activity to military duty. Consumer sentiment dropped in March 2026 and remained weak in April 2026. The impact on inflation, which remained stable at 1.9% year-on-year in April 2026, has been muted by international comparison, as electricity prices in Israel are largely insensitive to global natural gas prices owing to domestic extraction priced through long-term contracts.

Israel

1. Monthly data (average of daily data) for Credit Default Swap (CDS).

Source: LSEG; OECD Economic Outlook 119 database; and OECD calculations.

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Israel: Demand, output and prices

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The evolving conflict in the Middle East and broader trade tensions have contrasting effects on Israeli international trade. The sharp reduction in commercial flights complicates cross-border business travel, which is particularly important for the high-tech sector. Inward foreign tourism has dried up. Meanwhile, the Israeli economy is well positioned to respond to the increase in global demand for defence equipment and services.

Monetary policy easing can continue once fiscal consolidation resumes and supply conditions improve

Steady monetary policy management and fiscal responsibility have maintained currency and financial stability despite successive large shocks since October 2023. Credit default swap (CDS) rates, which summarise the market assessment of sovereign risk, went up by 20 basis points in late February‑ early March 2026 before returning in April 2026 to their January 2026 levels. Domestic stock exchange valuations have reached historical highs. The shekel has been appreciating since April 2025. After the 25 basis point cut of May 2026, the monetary policy stance can be further recalibrated once supply constraints, including those arising from reserve duty pressures on the labour market, abate. With supply improving, oil prices easing, and shekel appreciation feeding through, the central bank should be able to cut its policy interest rate to 3.5% in 2027.

Renewed intense military activity in 2026 entails large fiscal costs that delay consolidation. The government deficit is expected to widen to 5.3% in 2026 before narrowing to 4.2% in 2027, as defence spending decreases while revenue collection remains robust partly thanks to the continued implementation of measures taken in previous budgets.

Activity will rebound following the ceasefires

GDP is projected to grow by 3.3% in 2026 and 5.6% in 2027. Following the April 2026 ceasefires with Iran and in Lebanon, activity quickly recovered. Construction, which restarted already mid-March, will expand more quickly than before the wars including to repair damage from missile attacks. Pent-up demand for housing from past housebuilding reductions and strong population growth will fuel investment expansion. Consumption is anticipated to bounce back quickly as in the aftermath of previous recent episodes of armed conflict. The recovery in service exports will be slower, as it partly depends on international air travel, which resumes more sluggishly. Inflation will decrease over 2026-2027, as motor fuel prices abate from their April 2026 highs and civilian labour-market shortages ease. Risks abound on both sides: renewed intense warfare would hurt activity and widen the deficit, while a global slump in AI valuations would threaten Israel’s high-tech sector. On the upside, trade agreements with countries in the region would unleash stronger growth.

Macroeconomic policy should remain cautious

Exposure to recurring large shocks calls for restoring the ample fiscal buffers that have served the country well. This requires quickly reducing government debt by maintaining the revenue-raising measures introduced in recent budgets and diminishing defence spending when security conditions allow. As a priority to enable strong future growth, fiscal room should be kept for needed public spending on education and infrastructure while simplifying planning and permitting procedures.