Israel Bank Report: Economy Enters a "Positive" Growth Phase in 2026

SadaNews - The Research Unit at the Bank of Israel announced at the beginning of January 2026 its report titled "Macroeconomic Forecasts", which discusses the bank's outlook on the trajectory of key economic indicators in Israel during the current year. The report includes estimates regarding GDP growth, inflation rates, and interest rate trends, along with a review of the economy's performance in 2025, and the bank's assessments of the level of stability in the global economy.

Economic Activity in Israel

Regarding the report's forecasts for key indicators in the Israeli economy, it clarifies that GDP growth in Israel for 2025 reached 2.8%, and is expected to grow at a high rate of 5.2% in 2026 and 4.3% in 2027. The ceasefire in Gaza has accelerated the easing of labor supply restrictions in markets, particularly due to the demobilization of reserve forces and their return to the labor market in the private sector. Private consumption is expected to return to a path of moderate growth (at a rate of 4.3% in 2026), at a pace similar to GDP growth, following limited damage at the beginning of the war.

The Bank of Israel also expects investments in the economy to grow rapidly and to exceed the original trend level, aiming to close the capital stock gaps that have arisen in the private sector and in the housing market. This trajectory is supported by the recovery of the construction sector as the number of workers in it returns to its pre-war levels, along with increased investment in equipment and machinery as an alternative to the shortage of labor, amidst rising capital productivity, among other reasons, resulting from the shift to building taller buildings.

At the same time, the report anticipates an increase in both import and export shares in economic activity, in line with the long-term trend of increasing openness of the Israeli economy, with a slower decline in the trade surplus thanks to the easing of supply restrictions. Conversely, public consumption is expected to slow down after two years of high military spending, with a change in the composition of spending in favor of civilian expenditures, and a decline in public consumption prices due to reduced wage payments to reserve soldiers.

The report from the Research Unit at the Bank of Israel projects that the budget deficit will reach 3.9% and 3.6% of GDP in 2026 and 2027 respectively, and that the debt-to-GDP ratio will rise to 68.5% in these two years.

The report assumes that the government budget will be approved by the end of the first quarter of the year without significant changes from the framework approved by the government. The forecasts indicate that without making adjustments to fiscal policy (such as raising taxes or cutting spending), the debt-to-GDP ratio is not expected to decline.

The report sees that the inflation rate during the next four quarters will be about 1.7%, reaching 2.0% in 2027.

Main Risks Surrounding the Forecasts

The level of uncertainty surrounding the economic forecasts has decreased following the ceasefire in Gaza; however, the balance of risks remains complex. On one hand, there is a possibility of demand expanding faster than the estimates in the baseline scenario, which could lead to a faster increase in financial inflation in a tight labor market with shortages of workforce. On the other hand, geopolitical risks remain: while the possibility of reopening fronts or widespread war poses a central threat to price stability, political breakthroughs and the expansion of Abraham Accords could represent a positive factor for the Israeli economy, according to the Bank of Israel.

Additionally, the continued possibility of bringing elections forward remains a source of uncertainty, with potential impacts on public financial developments and the budget.

The report's forecasts are based on the assumption of continued relative calm on various fronts. However, we estimate that supply constraints remain in place, and their easing will only be gradual, thanks to the continued gradual increase in youth participation in the labor market after military service and an ongoing rise in the number of foreign workers. However, even by the end of the forecast horizon at the end of 2027, the number of employees is expected to remain below the level extrapolated from pre-war trends, due to the increased size of reserve service compared to the past, and a portion of war casualties remaining out of the labor force, in addition to a negative migration balance.

The Ceasefire in Gaza Eased Pressures on the Economy

The Bank of Israel report explains that the ceasefire in Gaza, which was accompanied by the earlier timing of easing labor supply restrictions in the economy, contributed together to alleviating excess demand for labor and reducing financial inflationary pressures. A decrease in risk costs for Israel was also recorded, along with a decline in yield spreads in dollars, alongside a rise in the value of the shekel. These factors collectively, along with a decline in oil prices and the expected low inflation rate in developed countries, help to calm the inflation environment, and strengthen expectations for the continuation of the interest rate reduction path initiated by the Bank of Israel in November 2025.

Interest rates of the Bank of Israel are expected to hover around 3.5% in the fourth quarter of 2026. These forecasts reflect a gradual decrease in the interest rate from its current level, corresponding to the pace of convergence of inflation toward the target center.

The ceasefire and the reduction in geopolitical uncertainty support the expansion of economic activity, without signs of exceptional excess demand. Investments are expected to grow rapidly in response to the labor shortage, partially compensating for the years of investment slowdown. Additionally, both imports and exports are expected to expand at a rate relatively faster than the GDP growth rate.

The easing of supply constraints, the decline in security spending, and the reduction in risk costs for Israel, alongside the rise in the value of the shekel, contribute to calming the inflation environment, which is expected to stabilize around the target specified in law, and these factors support the path of interest rate reductions that began in November 2025. Therefore, any change in these factors could disrupt the direction of the Israeli economy's return to stability and growth, and potentially prompt a revision of the Bank of Israel's forecasts.