The Israeli economy goes into 2022 in a favourable position. After a strong recovery in 2021, growth is likely to receive continued support from household consumption and exports. Although inflation is rising, it remains under control, which should allow the continuation of an accommodative monetary policy. Macroeconomic fundamentals remain very favourable for the shekel, although monetary tightening in the US and a possible correction in US equity markets could slow its rise. The vulnerability of public finances to an increase in interest rates remains limited, due to the essentially domestic financing of the budget deficit and the low risk of any substantial monetary tightening in the short term.
A strong economic recovery
ForecastsThe Israeli economy has held up well in the face of the pandemic. Real GDP contraction in 2020 (-2.2%) was one of the smallest in the OECD and there was a strong recovery in 2021. Real GDP growth reached an estimated 6.7% over the year as a whole. Private consumption and investment were the two main engines of the recovery. The effectiveness of the vaccine campaign (at least over the first three quarters of the year) allowed restrictions on mobility to be lifted. Household purchasing power has been sustained by moderate inflation and the reduction in unemployment over the course of the year. The unemployment rate (on its broad definition, which includes those deprived of work, even on a temporary basis, due to the pandemic) was 6.3% at the end of 2021, down from 13.2% a year earlier, whilst the employment rate has almost returned to its pre-pandemic level. Strong growth in investment (+14% y/y in Q3 2021, from +16% in Q2) was driven both by investment in residential real estate and productive investment in industry. Conversely, although exports, particularly of hi-tech services, remain an important source of support (+13% y/y over the first three quarters), the recovery in domestic demand has boosted imports (+20% y/y over the first three quarters), thus implying a negative contribution of net foreign trade to growth.
In the short term, economic activity is likely to remain strong, with growth projected at 5% in 2022. However, the resurgence of Covid-19 with the omicron variant could threaten this forecast. The variant is spreading in Israel, lagging Europe somewhat, but the government has so far opted in favour of mobility, by keeping restrictions as light as possible. However, infections are rising rapidly and some indicators argue for caution. Mobility indicators have once more been moving downwards since the beginning of the year and are well below their levels at the end of 2019. According to the Bank of Israel, credit card purchases have been losing steam since the end of 2021. Household consumption’s capacity to continue to support growth could thus diminish, at least in the short term. Moreover, government support measures to households and corporates are gradually being scaled back. On the supply side, many sectors are suffering from difficulties in recruitment, particularly in services, whilst industry and construction are experiencing supply disruptions for materials and certain capital goods.
Medium-term growth prospects are favourable, thanks particularly to the competitiveness of certain sectors, most notably hi-tech. The limited economic recession seen in 2020 relative to other OECD members highlights the solidity of the Israeli economy. This said, a number of structural weaknesses remain and could hold back potential growth. Growing inequality remains a major weakness, fuelled by continued increases in property prices. There was a strong rebound in residential real estate prices over the course of 2021: they rose 10.3% y/y in October 2021, their biggest jump since mid-2011. Meanwhile, the OECD has highlighted the low level of labour productivity, which is 35% below that of the best performing OECD members. This is notably due to the marked dichotomy between hi-tech sectors and the more traditional economy, which has a domestic focus.
Inflation is under control
Consumer price inflation accelerated during 2021, but remained well below the average for OECD countries. It was 2.4% y/y in November 2021, against an average of 5.8% for OECD members. Underlying inflation reached 2.5%, confirming the moderate inflationary pressures. Spending on housing (including energy) and transport have been the main contributors to the increase in inflation, whilst the continued appreciation in the shekel has helped keep it in check. More structurally, progress towards energy self-sufficiency, made possible by the exploitation of national gas reserves, has reduced vulnerability to rises in international energy prices. For 2021 as a whole, inflation is likely to have averaged 1.5%. In 2022 it is likely to rise a little to 1.7%, with the introduction of certain taxes, a smaller rise in the shekel and persistent pressure on international supply chains. Wage inflation remains under relatively good control for the time being, but some sectors (construction and the IT and communications industry) have seen increases in average wages of more than 13% since the end of 2019.
