OECD Economic Outlook, Volume 2025 Issue 2

Israel

Growth is projected to pick up from 3.3% in 2025 to 4.9% in 2026 and remain strong at 4.6% in 2027, following the release of the hostages and the ceasefire. The private sector will lead the economic expansion as military expenditure contracts. With supply constraints easing, inflation is expected to subside from 3.1% in 2025 to 2.4% in 2026 and 2.0% in 2027.

Continued fiscal consolidation and monetary stability are key to private-sector-based growth. Efforts to balance public accounts should favour the most growth-compatible measures. This involves shifting from overall spending curbs to expenditure cuts based on a prioritisation exercise, safeguarding education and infrastructure, while increasing the least distortive taxes. Stabilising inflation at 2% while supply conditions improve calls for moderately further relaxing the monetary policy stance. Long-term growth would benefit from intensifying regulatory reforms.

Geopolitical improvements support a stronger economic expansion

The ceasefire has important economic ramifications, including a lower risk premium. Credit default swap rates came down by 30 basis points after the 12-day war with Iran in June. After the 12-day war brought economic activity to a standstill with GDP contracting by 1.1% in the second quarter, activity strongly bounced back with 3.0% growth in the third quarter. Subsequently, credit card purchases, a high-frequency indicator of consumer spending, bounced back strongly. Business sentiment had already improved before the ceasefire, with a positive balance (+21%) of respondents anticipating improvement in October. The labour market is robust with a 3.0% unemployment rate in September.

Israel

1. Daily data shown after exponential smoothing with half-lives of 10 and 5 days for purchases and Credit Default Swap (CDS) respectively.

Source: LSEG; Bank of Israel; OECD Prices Statistics database; and OECD calculations.

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Israel: Demand, output and prices

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International trade will gain from better geopolitical conditions and Israel’s industrial specialisation. The ceasefire should remove a source of reluctance to doing business with Israel. Merchandise exports expanded by 5.8% in August-October 2025 over the previous three months. The 10.2% effective tariff rate on Israeli merchandise exports to the United States is a moderate brake on goods exports. Trade in services is solid, with exports over January-August 2025 8.0% above their level a year earlier. Services exports to the United States, which are dominated by high-tech R&D and ICT, remain tariff-free. Looking ahead, the global boom in defence and cybersecurity will benefit exports.

Fiscal consolidation amid fading supply constraints enables monetary easing

The primary fiscal balance will tighten in 2026 and 2027 by a projected 2.6% of GDP. After the 7 October 2023 terrorist attacks, expenditures on displaced people and defence took the general government fiscal balance from a 0.3% of GDP surplus in 2022 to an 8.1% deficit in 2024. Revenue increases and non‑defence spending curbs enabled the deficit to fall to 5.4% of GDP in 2025 despite intense military activity. The geopolitical improvement will allow a reduction in defence expenditure by two percentage points over 2026-2027. This reduction, alongside non‑defence spending moderation and already planned revenue measures, is anticipated to help narrow the deficit to 4.1% of GDP in 2026 and 2.7% in 2027. The ceasefire also allows a gradual return of reservists to civilian employment, alleviating labour shortages. A better geopolitical situation moreover makes it easier to attract foreign workers. After two years of tight monetary policy, annual headline and core inflation fell to 2.5% and 2.2% in October 2025.The currency appreciated by 5.5% in effective terms over January‑October 2025. These developments, alongside supply-side improvements and fiscal consolidation, pave the way for the Bank of Israel to continue lowering its policy interest rate from 4.25% in November 2025 to 3.75% through 2026.

Private-sector dynamism will fuel activity

Growth is projected to rise from 3.3% in 2025 to 4.9% in 2026 and remain robust at 4.6% in 2027. Investment will be strong given the backlog accumulated during the war. Improved household confidence amid more peaceful conditions will support private consumption. Better conditions for international business will allow exports to regain some of the market share lost during the war. Inflation will moderate to 2.4% in 2026 and 2.0% in 2027 owing to lighter supply constraints and recent currency appreciation. Risks are broadly balanced: on the downside, returning warfare would widen the budget deficit and hurt private demand. On the upside, completing the peace agreement beyond the ceasefire could strongly boost growth, particularly in 2027, especially if new trade agreements were signed with large Middle‑Eastern countries.

Market regulation reforms should accompany fiscal consolidation

Sustaining private-led growth requires continued household and business confidence. Fiscal consolidation efforts should be completed and designed to preserve growth. On the expenditure side, this calls for shifting from across-the-board restraints to more targeted cuts, such as on transfers to religious students that discourage their labour market participation, while prioritising spending on infrastructure and education. Revenue-side measures should favour options such as raising carbon tax rates, removing VAT exemptions, implementing a mileage tax and taxing unused land, sugary drinks and single-use plastic items. Private-sector growth would strongly benefit from accelerating initiatives to unleash business dynamism, starting by cutting red tape on business creation, reducing entry barriers for professionals and importers, and streamlining building permitting procedures.