Bank of Israel slashes growth prospects as Iran war takes toll on economy

The Bank of Israel on Monday trimmed its growth outlook for the economy for this year and left interest rates on hold for a second straight meeting, citing high geopolitical uncertainty over the duration and toll of the war with Iran.

“Recent weeks, since the beginning of Operation Roaring Lion, have been marked by considerable geopolitical uncertainty, and the war’s impacts on the economy and on real activity can be seen across all industries,” Bank of Israel Governor Amir Yaron said at a press conference in Jerusalem.

“On the demand side, there is a decline in credit card expenditures and in tourism, and on the supply side, there is an adverse impact on labor supply due to employee absences and military reserves call-ups, alongside disruptions in the supply chains,” he said.

“However, even at this challenging time, the economy continues to show resilience, flexibility, and robustness, as has been the case for the past two and a half years as well,” Yaron noted.

Assuming that the war with Iran and the fighting in Lebanon will end in late April, the central bank said it expects the economy to grow by 3.8 percent in 2026, down from its January forecast of 5.2%, before the outbreak of the war.

Also on Monday, the Finance Ministry said it forecast the economy to expand at a slower pace of 3.3%-3.8% in 2026, depending on the duration of the wars on multiple fronts. Earlier this month, the ministry lowered its 2026 growth forecast from 5.2% to 4.8%, assuming that the war with Iran would be short-lived, a prediction that did not materialize.

“Insofar as the fighting continues, economic activity is being negatively affected mainly by restrictions on the home front due to missile fire and threats, absences from work due to the shutdown of the educational system, and mobilization of the military reserves,” the central bank said.

In 2027, the pace of growth is expected to pick up to 5.5% versus the 4.3% previously forecast, the central bank said. Israel’s economy grew 2.9% in 2025, which was overshadowed by the war with the Hamas terror group in ⁠Gaza for most of the year.

The central bank warned that even if the fighting ends in late April and is not renewed before the end of 2027, the mobilization of IDF reserves will be higher for several months.

“Defense spending has increased and is expected to remain elevated in the coming years,” said Yaron. “Consequently, the government faces a growing challenge in identifying sources that will allow for a reduction in the debt-to-GDP ratio, while simultaneously supporting defense needs and making the investments required to sustain long-term economic growth, chief among them improvements and investments in education and infrastructure.”

“It is therefore important to build fiscal buffers to prepare for future shocks or crises,” Yaron demanded.

He urged the government to take measures to eliminate expenditures that adversely impact growth, while boosting revenues.

“As the deficit will be higher than expected, it would have been appropriate to tighten the belts further, especially in budgets that do not support growth, to make the right adjustments, reduce the coalition budgets, and the expenses of less essential ministries,” said Yaron.

His criticism came after the Knesset early Monday morning approved the largest state budget in Israel’s history, growing the defense budget to unprecedented levels amid the war with Iran and sending billions of shekels to Haredi educational institutions and other priorities of the governing coalition.

Alongside the revised growth forecasts, the central bank decided to hold the benchmark interest rate at 4%, in line with forecasts by economists. In January, the Bank of Israel cut borrowing costs by 25 basis points from 4.25% to 4%. In November, it had lowered the benchmark lending rate for the first time in almost two years to 4.25% from 4.5%, following a ceasefire agreement with Hamas.

“Wars are generally inflationary and damage growth,” said Leader Markets Capital macroeconomist Jonathan Katz. “The labor market is tightening due to reserve mobilization, energy prices are rising, and flight prices are expected to increase.”

“These developments also support higher food prices [due to rising fertilizer costs],” Katz added.

The central bank expects annual inflation in 2026 to accelerate to 2.2%, and slow to 1.8% in 2027. In the coming year, interest rates are forecast to be cut once or twice, to 3.75% or 3.5%.