Weekly report, May 18, 2026: Early elections move closer, April CPI in line, and Q1 GDP better than expected; market focus shifts to the Bank of Israel rate decision

ISRAEL - Report 18 May 2026 by Sani Ziv

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Key developments and outlook:

- The main political development this week was the growing likelihood of early Knesset elections in September, after coalition parties submitted a bill to dissolve the Knesset amid rising dissatisfaction among ultra-Orthodox parties over delays in military conscription exemption legislation.
- At the geopolitical level, alertness remains high around the potential scope and nature of a possible American operation in Iran. Meanwhile, negotiations with Lebanon have shown limited progress, while Hezbollah continues to reject disarmament demands.
- On the economic front, Q1 2026 GDP contracted by 3.3% annualized, reflecting the temporary impact of the war with Iran (in March), when schools, businesses, and parts of the economy were partially closed.
- Due to the contraction, the output gap remains around 6% below potential GDP, reflecting the cumulative impact of the war since late 2023.
- Assuming the economy rebounds during the second quarter with GDP growth of around 3%, effectively offsetting the contraction recorded in the first quarter, annual GDP growth in 2026 could reach around 3.5%-4%.
- April’s CPI increased by 1.2%, in line with our expectations, with most of the increase driven by higher fuel prices and seasonal factors such as airfare, recreation and vacations, clothing, and fruit prices.
- Excluding seasonal components, the CPI remained almost unchanged, indicating that underlying inflationary pressures remain moderate despite the war and higher global energy prices.
- Annual inflation remained relatively low at around 1.9%, below the midpoint of the Bank of Israel’s target range. Non-tradable inflation also remained below 3%, while food prices were almost unchanged.
- Housing prices showed further signs of moderation: The annual rent index slowed to 2.9%, while rent increases in new contracts moderated significantly. This may partly reflect weaker rental demand in central Israel during the war months.
- The appreciation of the shekel—up by around 8.5% since the beginning of the year and nearly 18% over the past 12 months—and an expected easing in oil prices are expected to mitigate inflation in the coming months.
- Looking ahead, May and June CPI readings are expected to remain close to zero, while our 12-month inflation forecast stands at around 1.8%, supported by the stronger shekel, expectations for a gradual decline in oil prices, and a continued moderate demand environment.
- A low inflation environment and the appreciation of the shekel are increasing the probability of Bank of Israel rate cuts in the coming months, although geopolitical risks still support a cautious approach.
- Our baseline scenario assumes one rate cut either at the upcoming May meeting or the following meeting (July 6), followed by another cut during the fourth quarter of the year, bringing the policy rate to around 3.5% by year-end.
- The appreciation of the shekel continues to be driven mainly by the hedging activity of institutional investors, who are increasing FX sales amid gains in financial markets and reductions in foreign currency exposure. In contrast, foreign investors are moving in the opposite direction and increasing FX purchases, partly in light of the widening fiscal deficit, geopolitical risks, and relatively attractive valuations.
- No major economic data releases are expected in the coming week, and markets are likely to focus mainly on oil prices, reports regarding U.S. preparations for a possible operation against Iran, and discussions in Knesset committees regarding the timing of early elections.

Geopolitics

- Israel assassinated Izz al-Din al-Haddad, Hamas’s leader in Gaza, on Friday in an Israeli Air Force strike in Gaza. Al-Haddad was considered the last remaining senior Hamas leader directly linked to the October 7 attacks.
- In the Gaza arena, Hamas continues to reject key parts of U.S. President Donald Trump’s ceasefire and hostage-release framework, including demands related to disarmament. In response, Israel continues expanding its military control in Gaza.
- The U.S. and Israel continue close military coordination regarding the possibility of renewed airstrikes against Iran. According to Israeli media reports, the Trump administration may initially prefer a more limited American-led signaling campaign, partly due to concerns that broader Israeli strikes on Iranian energy infrastructure could trigger a wider regional escalation.
- Lebanon’s government reported “positive progress” following the third round of talks between Lebanese and Israeli representatives in Washington this week. However, Hezbollah continues to reject disarmament demands and insists that any future ceasefire arrangement must include changes to the post-November 2024 status quo, including Israel’s withdrawal from positions still held inside southern Lebanon.