Israel: Country Economic Forecast: 22 Feb 2012

Although Israel posted GDP growth of 4.8% for the second successive year in 2011, the quarterly pace of growth slowed through the year to 0.8% in Q4. And recession in Europe, which takes a third of Israel's exports and is a key source of tourists, is weighing heavily on output and exports. Exports fell 4.7% on the quarter in Q4, after a 2% drop in Q3, and the January PMI pointed to further falls in exports and output in early 2012. The Bank of Israel is forecasting growth of 2.8% in 2012, but this appears over-optimistic. Given the slowdown that we see in the Eurozone where GDP is now forecast to shrink 0.4% we still expect Israel to grow by just 2.4% in 2012, before a pick-up to about 4% in 2013 as world demand begins to recover. Mounting fears about the economic outlook prompted 25bp rate cuts by the central bank in September and November last year and then again in January 2012. These cuts will help to shield the economy if the situation in the Eurozone were to deteriorate further. With inflation seen staying subdued, a further modest reduction in rates remains likely. Inflation was above target for much of 2011 but the rate fell back into the 1-3% range in September and slowed further to 2.0% in January 2012. We expect inflation to average 2-2.5% this year, down from 3.4% in 2011. But as the slowing economy hits tax revenues and defence spending rises, the fiscal deficit may edge up to a little over 3% of GDP in 2012.