Israel’s economy grapples with war impact: Bank of Israel report

Investing.com -- The Bank of Israel, the country’s central bank, has unveiled the first chapter of its 2024 annual report, providing insights into the state of the economy amid ongoing warfare. The full report is set to be released on March 31, 2025.

The war significantly affected the economy in 2024, primarily due to supply constraints, including a shortage of workers. The Gross Domestic Product (GDP) grew by a mere 0.9% compared to 2023, while business output shrank by 0.8%. Despite some recovery as the intensity of the war decreased, GDP and most of its components remained lower throughout the year than before the conflict began.

The report also highlighted the global environment, which was relatively favorable in terms of demand, as indicated by global GDP growth and increased world trade. Inflation in advanced economies moderated, and central banks cut interest rates.

However, the easing of supply constraints in Israel was gradual, 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.

To balance the immediate needs of the war with maintaining a sustainable fiscal path, the government financed ongoing war expenses by increasing public debt, which surged to about 68% of GDP. The government also implemented restrictive fiscal measures, mostly in the 2025 budget, to offset the expected permanent increase in expenditures due to the war.

Annual inflation in 2024 was 3.2%, slightly higher than in 2023, due to a gradual recovery in demand alongside persistent supply constraints. This contrasted with the global trend of moderating inflation. In response to the stabilization of the financial markets, a moderation of the inflation environment, and reduced war intensity, the Bank of Israel lowered the interest rate by 0.25 percentage points at the start of the year. The interest rate remained at 4.5% throughout 2024 to support market stability amid the ongoing war and to bring inflation back to the target range.

The labor market was tight due to the scarcity of workers, which led to a rapid rise in nominal wages and the unit labor cost. The construction industry faced a severe shortage of workers, resulting in extended construction times, a slowdown in building completions, and increased financing costs for contractors. Housing demand initially declined due to the war but later recovered, with the number of transactions and mortgage volumes increasing, along with rising home prices.

The economy’s risk premium increased significantly at the start of the war and exhibited volatility and a moderate upward trend for most of the year, due to increased geopolitical risk and a significant rise in the debt-to-GDP ratio. However, toward the end of 2024, the markets experienced a turnaround following a ceasefire in the north and assessments that security risks had decreased. The shekel appreciated, local stock prices soared, and the economy’s risk premium decreased, though it remained higher than before the war.

The Bank of Israel’s report also pointed to the increased challenge of addressing fundamental economic problems such as low labor productivity and high poverty rates through increased public investment in human capital and infrastructure. The economic necessity of quickly integrating additional population groups into the labor market and sharing the burden of military service has become more pronounced due to the war and its expected long-term effects on public expenditure growth.

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