“The Israeli economy is built on solid foundations and has demonstrated impressive resilience and stability throughout the war. Yet, the economic consequences are far-reaching and continue to leave a significant mark on economic activity.” With these words, Bank of Israel Governor Prof. Amir Yaron opened his remarks following last week’s interest rate decision, capturing the fragile equilibrium in which Israel’s economy has operated since October 7, 2023.
For nearly two years, Israel’s economy has weathered a prolonged war of attrition that has touched every sector. Signs of resilience—such as a stable banking system, a functioning credit market, and robust capital raising in high-tech—stand in contrast to emerging cracks: a sharp decline in exports, rising imports, labor shortages, and inflation hovering at the upper limit of the target range, with expectations it may soon exceed it.
In its latest forecast, the Bank of Israel projects modest growth of just 2.5% in 2025, contingent on the war ending by Q1 2026. The debt-to-GDP ratio is expected to remain elevated at around 71%, while the budget deficit is set to climb above 5%. These figures suggest an economy that continues to function, but under the weight of a persistent slowdown.
When asked to identify a defining feature of the Israeli economy since the war began, Governor Yaron offered two: “Uncertainty, which leads people to become more defensive, whether by cutting investments and consumption, and supply constraints, particularly the shortage of workers, which heavily influences our GDP projections.”
The prolonged drafting of tens of thousands of reservists, coupled with the absence of Palestinian labor from Gaza and the West Bank, has created a severe labor shortage. This, combined with uncertainty, has produced a dual bottleneck: weakened demand alongside limited production capacity—both of which shape the economic outlook.
Israel Bank weighs end of war
According to Yaron, the past two years have deepened the Bank’s understanding of how war—and especially widespread reserve call-ups—directly impact GDP, consumption, and employment. As a result, forecasts have become more cautious and scenario-based, reflecting the ongoing uncertainty and supply limitations.
Still, there are glimmers of recovery. Credit card spending has rebounded above trend, exports are recovering from their steep decline, and construction activity is surging, with building permits at high levels. “If you look at the full spectrum—credit cards, production, exports, housing starts, and permits—you see a relatively strong revival,” Yaron noted.
Yet the risks remain. Inflation is back and could rise further. The labor market appears “tight,” a metric often seen as a sign of economic strength—but in this case, it’s largely due to the absence of reservists and foreign workers, not organic growth.
So what happens if the war ends tomorrow? If tens of thousands of reservists return to the workforce, along with 150,000 Palestinian laborers from Gaza and the West Bank, could Israel face mass unemployment?
“There will certainly be changes,” Yaron said. “A process that brings sustainable security, an end to fighting, and improved sentiment could ease supply constraints. But it would also likely trigger a surge in demand-and we may even see euphoria in the markets. The challenge is predicting the timing and intensity of these shifts.”
In other words, even the most optimistic scenario does not guarantee a soft landing. The labor market may be flooded, but whether demand will rise fast enough to absorb the influx remains uncertain.
Two years into the war, the governor’s assessment is clear: Israel’s economy continues to function, showing resilience and signs of recovery-but under heavy constraints and persistent uncertainty.
This is Israel’s economic reality right now. What will happen from here on out – whether we will see a new path or a deepening erosion – depends on the policy decisions that the government will make.