Bank of Israel Warns of Post-Election Political and Economic Risks

The Bank of Israel has issued a warning regarding potential political and economic dangers that could emerge following the upcoming Knesset elections. These risks include the possibility of an inconclusive electoral outcome, deepening social divisions, and damage to institutional independence. The warnings were detailed in the Bank of Israel's economic forecast report, published by its research division on Thursday. The report noted that its projections do not account for the potential impact of the election results on the economy, with the baseline scenario assuming a relatively low level of ongoing conflict and continued geopolitical tensions.

Specific risks highlighted by the report involve a lack of a clear electoral mandate, increased internal societal divisions within Israel, and potential harm to the independence of institutions. Additionally, the report cautioned about the possibility of stricter international sanctions being imposed on Israel. The bank warned that a wider resumption of hostilities could lead to increased reserve duty call-ups, exacerbate labor shortages, and drive up military spending and prices, thereby hindering economic recovery. It also pointed out that renewed conflict with Iran could impact the global economy, particularly through rising energy prices.

Regarding public finances, the Bank of Israel anticipates a rise in the budget deficit from 4.4% of GDP in 2026 to 4.6% in 2027. This projected increase for next year is primarily attributed to higher military expenditures. Conversely, the bank forecasts the Israeli economy to grow by 5.6% in 2026 and 7.5% in 2027. However, it clarified that these figures are significantly influenced by the production of Israeli companies operating abroad and do not necessarily reflect the extent of economic activity within Israel. Excluding this overseas production, growth forecasts drop to 3.4% and 5.1%, respectively. The bank further explained that a substantial portion of profits from foreign operations accrues to foreign shareholders, not directly impacting employee wages or household income.

Despite projections of recovery, the Bank of Israel expects domestic economic activity to remain below its pre-war trajectory through the end of 2027. This is due to persistent labor shortages and reduced labor market participation rates. The Bank of Israel emphasized that these forecasts are contingent upon security and political developments, as well as the decisions of the government formed after the elections, particularly concerning the defense budget, tax policies, and public spending.