What is the state of the Israeli economy amid rising inflation and interest rates?

The Bank of Israel raised its benchmark interest rate from 0.35% to 0.75% in May – making it the second consecutive month that the central bank raised its interest rate in an effort to combat rising inflation in Israel. 

Despite the waning economic effects of the pandemic, Israel – like the U.S. and many other economies – now fears rapidly growing consumer prices due to the war in Ukraine and other global turmoil. 

What is the overall state of the Israeli economy and how does it fare compared to the U.S. economy?

In late May, the Bank of Israel announced that Israel's economy appeared to be growing and gradually recovering from the pandemic. 

“Economic activity in Israel is continuing at a high level. Indicators of economic activity continue to show levels close to potential, and the pandemic’s effect on the economy has declined significantly,” said the bank in its official statement. 

At the same time, however, the bank cautiously warned of negative effects on the Israeli economy stemming from the war in Ukraine and the slowdown in the Chinese economy. 

“The war in Ukraine and its effects, as well as the slowdown in economic activity in China due to the increase in COVID-19 morbidity there and policy’s response to it, are extending the interruptions in the global production chain, despite some decline in shipping prices,” the Bank of Israel said. 

Inflation in the Israeli economy has been growing in recent months amid fears that it would simultaneously push consumer prices further upwards. In April, economists estimated that the growing Israeli inflation had reached 4% annually, the highest inflation rate in the Jewish state in over a decade. This inflation rate exceeded the Israeli government’s target range of 1 to 3%. 

The rising inflation consequently also gradually affected the cost of living in Israel. The already sky-high housing prices in Israel have increased by 16.3% in the past twelve months, which constitutes the highest increase in a decade. At the same time, consumer prices in Israel continue climbing for food, clothes, footwear and a range of other products. 

While there are reasons for concern, Bank of Israel economists have stressed that Israeli inflation is still low compared to many other countries. 

"Inflation is higher than the target range, but it is low by global comparison,” stated the Bank of Israel. 

The current Israeli inflation rate is indeed low, compared to many other advanced economies, including the United States. While Israeli economists are concerned about an annual inflation of 4%, the U.S. inflation rate reached 8.3% in April. Current inflation remains close to the highest level in 40 years, increasing fears of rising costs of living in America. In the past 12 months, energy costs in the U.S. increased by 30.3%, while food prices increased by 9.4%.  

“The markets were hoping for a better number and it’s not good enough to rule out more Fed tightening,” said Kathy Jones, chief fixed income strategist at Charles Schwab. 

While Israel’s overall current macroeconomic data is fairly stable in comparison to many other economies, there are still dark clouds on the horizon. Following a period of post-pandemic economic expansion, Israel’s Gross Domestic Product (GDP) surprisingly fell by an annualized 1.6% during the first quarter of 2022. 

With the exception of rapidly climbing housing prices, consumer prices in Israel have, nevertheless, increased more moderately in recent months compared to many other advanced economies. 

However, this statistic needs to be contextualized. Even prior to the pandemic and the Russia-Ukraine war, costs of living in Israel were already among the highest in the world. Despite recently rising expenses in America, consumer prices, excluding rent in the U.S., are still about 13% lower than in Israel. 

At the same time, the average purchasing power in the U.S. is almost 36% higher than in Israel. While the Israeli economy is overall in fairly good shape, it is far more vulnerable to global turmoil than the U.S. economy.