Weekly report, May 29, 2026: Bank of Israel cuts rates, the shekel strengthens further, and the U.S.-Iran deal is still being negotiated

ISRAEL - Report 29 May 2026 by Sani Ziv

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Key developments and outlook:

- Negotiations between the United States and Iran continued this week, although President Trump stated that “there is no agreement at the moment” and that the U.S. remains dissatisfied with the talks.
- According to reports, the agreement will include restrictions on Iran’s nuclear program, the removal of 60% enriched uranium, partial sanctions relief, reopening the Strait of Hormuz, and a broader regional ceasefire.
- Fighting along Israel’s northern border continued this week, as Hezbollah maintained attacks against Israeli forces while Israel expanded its military operations in Lebanon despite ongoing diplomatic efforts tied to the negotiations.
- Israel’s political system is increasingly shifting into election mode, with growing tensions between Benjamin Netanyahu and the ultra-Orthodox parties over the military conscription issue. Elections are likely to be brought forward to mid-September, instead of the originally scheduled date of October 27.
- The Bank of Israel lowered its benchmark interest rate by 25bps to 3.75%, supported by the appreciation of the shekel and moderating inflation pressures, although the accompanying statement remained relatively hawkish. The bank emphasized continued inflationary and fiscal risks related to geopolitics, energy prices, labor shortages, and uncertainty around defense spending.
- Despite the Bank of Israel’s decision to lower the policy rate, the move has so far failed to weaken the shekel. The Israeli currency continued to appreciate, reaching another record against the U.S. dollar, with the USD/ILS exchange rate falling to 2.811.
- The rapid appreciation of the shekel has fueled growing debates in Israel, as the Bank of Israel shifts away from active FX intervention and focuses primarily on low inflation and price stability, despite the impact on exporters, high-tech, and the broader real economy. At the same time, the Ministry of Finance, which in the past sought to moderate shekel appreciation through hedging programs and other measures, has so far refrained from intervening, partly due to political and election-related considerations.
- As a result, we revised down our inflation and interest-rate forecasts. Assuming the ceasefires with Iran and Lebanon hold, we expect inflation in 2026 to fall to 1.6%–1.8% and the policy rate to decline to approximately 3.25% by year-end.
- Israel’s Composite State of the Economy Index declined in April, reflecting weaker activity during the war period, although the contraction remained milder than during previous major military escalations.
- Labor-market conditions remain tight: The broad unemployment rate fell to 6.4% compared to 15% in March, participation rates remained below pre-war levels, and labor shortages continued to support wage pressures.
- Inflation expectations among forecasters declined sharply due to the appreciation of the shekel, even as global inflation expectations increased following higher oil prices and geopolitical tensions.
- Mortgage lending recovered moderately compared with 2025 lows, although activity remains significantly below the levels seen during the housing boom of 2021-2022.
- Looking ahead, markets will closely monitor next week’s releases of services exports, credit-card purchases, wage data, and tourism indicators for signs of economic recovery and continued foreign-currency inflows into the Israeli economy. Investors will also remain focused on developments in the FX market following the Bank of Israel’s indication that it is unlikely to intervene despite the shekel’s sharp appreciation.