Inflation is back on investors’ radar globally. Energy prices are rising, geopolitical risks remain elevated, and in many economies the concern is that a shock to oil and gas prices could force central banks to keep interest rates higher for longer or even consider additional tightening. In Israel, at least at this stage, the picture is somewhat different. This is due both to a weaker transmission mechanism from energy prices to inflation and to the shekel’s appreciation, which is acting as a meaningful offset to a large share of imported price pressures.
That said, it is important not to confuse relative insulation with detachment from global forces. Oil prices still affect fuel, transportation, airfares, and parts of production inputs. However, Israel’s pass through from energy prices to inflation is weaker than in many other economies particularly compared with Europe.
The first reason relates to the structure of Israel’s domestic energy system. Unlike economies that depend heavily on imported natural gas and are therefore directly exposed to sharp swings in global energy prices, Israel relies to a significant extent on domestically produced natural gas. Local gas reserves, long term contracts, and pricing mechanisms that are not fully indexed to global energy benchmarks provide a degree of cushioning. Since a large share of electricity generation in Israel is gas based, global energy shocks do not translate immediately or as forcefully into household and business electricity costs.
A second factor is the weight of “direct energy” items in Israel’s CPI basket. In Israel, direct energy components – fuel, electricity, and gas, make up a smaller share of the CPI than in many other countries. As a result, even when energy prices rise, their direct contribution to headline inflation is relatively more limited. Israel’s fuel taxation structure also acts, somewhat ironically, as a shock absorber – because a significant share of the retail fuel price reflects a fixed tax (around 60%), an increase in global oil prices does not pass through one for one to the final price paid by consumers. In addition, electricity and water prices are regulated and adjusted periodically, rather than moving with daily or monthly volatility as in other markets.
Above all, the shekel is a key driver reshaping Israel’s inflation outlook. Shekel appreciation is clearly disinflationary – it reduces import costs, offsets part of the USD denominated rise in commodities, particularly energy, and helps anchor inflation expectations. This is why, while many economies are again facing concerns about persistent inflation, Israel’s realized inflation and inflation expectations have remained around the midpoint of the price-stability target range. It also helps explain why the monetary policy discussion differs materially across regions. In the U.S., markets have leaned toward a “higher for longer” stance, and in Europe the conversation has even shifted back toward the possibility of rate hikes. In Israel, by contrast, markets still price rate cuts over the coming year, potentially sooner than previously expected, especially if the shekel’s strength continues.
However, alongside the optimism around a strong shekel, it is important to recognize the tradeoff. A very strong currency is not an unambiguously positive story. While it helps reduce inflation, it can weigh on one of Israel’s key growth engines – Exports. When the shekel is appreciated, exporters’ revenues in shekel terms decline, competitiveness can weaken, and profit margins may come under pressure. Yet here too the picture is more nuanced, and more encouraging, than in the past. Bank of Israel research shows that export sensitivity to the exchange rate is not uniform across sectors. In manufacturing, the sensitivity is higher – a 1% real appreciation is associated with roughly a 0.8% decline in exports for the average firm, with a lag of around two years. In other words, for more traditional goods producing industries, a strong shekel can be a meaningful headwind. In contrast, sensitivity is much lower in business services, especially in high-tech, at roughly 0.3%. The intuition is straightforward – many service exporters rely on specialized human capital and high value added, offering products and services that are harder to substitute purely on price. Put simply, when an Israeli firm sells technology, software, cyber solutions, or advanced services, foreign clients are not choosing it solely because of the exchange rate, but because of expertise, innovation, and comparative advantage.
Bottom line, Israel currently benefits from a relatively unique combination of factors – an energy system that partially insulates it from global energy shocks, a strong shekel that moderates imported inflation pressures, inflation expectations anchored near the target midpoint, and an advanced export mix that reduces exchange-rate sensitivity. This does not eliminate risks. Persistently high energy prices, a sharp depreciation, or renewed geopolitical escalation could still shift the outlook. But now, while much of the world is again grappling with inflation risks and the prospect of higher interest rates for longer, Israel appears to be in a relatively favorable position.
Matan Shitrit is Chief Economist at Phoenix Financial
