OECD Economic Outlook, Volume 2025 Issue 1

Israel

Economic activity is on a path to expand by 3.3% in 2025 and by 4.9% in 2026. The ceasefire in Lebanon at the end of 2024 brought a significant improvement in the economic environment spurring exports and private consumption. With a tight labour market and lingering supply constraints, inflation is anticipated to remain high at 3.2% in 2025 before moderating to 2.9% in 2026. Risks are substantial, hinging on regional geopolitical developments.

Implementing the fiscal consolidation planned for 2025-2026 is important to secure fiscal sustainability while creating buffers. Monetary policy must remain tight to ensure that inflation durably falls back within the 1-3% target range. Strong population growth necessitates investment in physical and education infrastructure accompanied by reforms to remove regulatory barriers and restructure the education system so that it can deliver high-quality teaching for all.

The recovery is accelerating

The economic recovery has gathered strength since the ceasefire in Lebanon at the end of 2024, with GDP expanding at an annualised rate of 3.4% in the first quarter of 2025. By removing most of the threat of rocket fire over the north and centre of the country, the ceasefire strongly improved the economic environment with long-term bond yields consequently falling by more than half a percentage point since October 2024. Foreign airlines returned to the Tel Aviv airport, facilitating international business and a recovery of high-tech investment. The improvement in living conditions enabled consumption to remain strong. Despite the one-percentage point VAT rise at the start of 2025, credit card purchases by March 2025 overtook their level in December 2024, which had been boosted by advance buying ahead of the VAT increase.

Israel

Source: OECD Labour Statistics database; OECD Price Statistics database; Bank for International Settlements (BIS); and OECD Economic Outlook 117 database.

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Israel: Demand, output and prices

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Global trade tensions and the appreciation of the shekel have slowed the export recovery that started in the second half of 2024. Tariffs on the 28% of Israeli merchandise exports that ship to the United States average below 7%. Services, which make up much of Israel’s exports to the United States, remain outside the scope of the new US tariffs. The effective exchange rate appreciation since October 2024 is also reducing import price inflation. Imports of goods are also facilitated by the “What’s good for Europe is good for Israel” reform, whereby goods meeting EU standards across a wide range of categories are deemed compliant with Israeli standards.

Macroeconomic policy is adequately tight

The fiscal stance is set to tighten in 2025 and 2026. After rising from 4.2% of GDP in 2022 to 8.0% in 2024, military expenditure will fall, albeit to a higher level than before October 2023. Simultaneously, government receipts are poised to rise in 2025-2026 following the VAT rate increase, the new tax on undistributed profits of some holding companies, the increase in national insurance contributions, the freeze of personal income tax brackets and other revenue-generating measures. Despite this fiscal tightening and the currency appreciation, monetary policy is expected to remain restrictive as, at 3.6% in April 2025, inflation lies above the 1-3% target range, while the labour market remains very tight with 2.7% unemployment in April 2025. Furthermore, persistent labour shortages in construction constrain supply.

The private sector is set to drive growth

Activity is set to expand by 3.3% in 2025 and 4.9% in 2026 under the impetus of private consumption and exports. Inflation is anticipated to reach 3.2% in 2025 reflecting a very tight labour market and lagged effects of acute supply constraints in 2024. Fiscal consolidation and tight monetary conditions together with easing supply constraints are projected to bring inflation back to 2.9% in 2026. Risks are large but balanced. On the upside, a peaceful settlement of ongoing conflicts would reduce sovereign risk. New diplomatic agreements with countries in the region would durably boost trade. On the downside, broader regional conflict could result in economic contraction and a large widening of fiscal deficits. Deepening unrest in relation with judicial reform plans could also derail high-tech dynamism, especially if it involved significant high-skilled labour emigration.

Forward-looking economic management is paramount

Macroeconomic policy needs to remain prudent to keep the economy on track for a balanced recovery. Besides maintaining the revenue-raising instruments already deployed, the government should lower transfers and subsidies that can discourage labour market participation. Monetary policy needs to remain restrictive until inflation is set to come durably into the target range. Looking ahead, strong demographic growth calls for substantial investment in physical capital, to address infrastructure gaps, and in education, to maintain the strong skills base that the high-tech sector and the rest of the economy require to reap the dividends of AI and digitisation. In addition, infrastructure and education both require structural reforms to remove unnecessary regulatory obstacles to entry, competition and investment and ensure that the education system works well for pupils across population groups.