Economic Uncertainty in Israel Amidst Ongoing Conflict in Gaza and Global Market Volatility

As the fifth week of fighting continues in the region, Israel is facing a high level of uncertainty on the military front, while the home front shows signs of adjusting to a new normal. Despite the ongoing conflict, there has been a notable increase in credit card purchases in the past two weeks, although they remain approximately 20% lower than pre-war levels. Traffic on the roads has also resumed with a partial return to school.

A recent business survey conducted by the Central Bureau of Statistics (CBS) revealed that 37% of all businesses reported a significant reduction in employment, which is not surprising given the high number of conscripts and economic disruptions in sectors like construction, leisure, and entertainment.

The economic consequences of the conflict are expected to be substantial, with a decline in economic activity in the fourth quarter of this year that is comparable to the impact of the COVID-19 pandemic. While it is possible that data may show a less severe economic downturn due to increased war-related expenses such as wages for recruited workers, it is difficult to estimate the exact magnitude of the short-term deficit increase, which also depends on American aid.

The U.S. House of Representatives recently approved $14.3 billion in aid to Israel, though this is not the Democrats' original proposal and may face challenges in the Senate. Regardless, it reflects bipartisan willingness to provide substantial assistance, primarily for military procurement. Even with this aid, Israel is expected to experience a high deficit, with Finance Ministry officials citing numbers that may reach about 4% of GDP this year and 5% next year. As a result, the treasury has increased bond raising in both local and foreign markets.

Despite these challenges, the local markets have remained relatively stable, with bond yields in shekels maintaining a 20 basis point gap below American bonds, similar to the level observed at the outbreak of the conflict. The Israeli shekel has experienced a modest depreciation of around 2% compared to the pre-war exchange rate, possibly influenced by sharp price increases in global stock markets and signals from Hezbollah leader Hassan Nasrallah hinting at reluctance to join the war.

Similar to the challenges faced during the COVID-19 pandemic, disruptions in measuring inflation are expected during the war. Factors such as reduced international travel and limited real estate transactions during the conflict may not be accurately reflected in inflation measurements. While the Treasury aims to stabilize fuel prices, it may become increasingly difficult due to the high budget deficit.

Economists have moderated price forecasts for the coming months, but they maintain a 12-month inflation forecast of 2.8%. The Bank of Israel emphasizes its focus on maintaining stability in these uncertain times.

Looking ahead, market expectations are for a gradual reduction in interest rates beginning in early 2024, with the interest rate expected to reach approximately 3.75% by the end of that year. In a situation of a high budget deficit, it is unlikely that the Bank of Israel will adopt a significantly different policy from the U.S. Federal Reserve, potentially allowing only for a slight reduction before the Fed's moves.

The global economic landscape is also shifting, with signs of moderation in economic activity being viewed positively by markets. In the past week, stock indices around the world experienced sharp price increases, with the S&P500 index in the U.S. rising by 5.9% and the EuroStoxx 50 index in Europe rising by 4.0%. Most central banks in developed economies, including the U.S., the Eurozone, and the UK, have left interest rates unchanged in their latest decisions. While inflation is moderating, economic activity varies between the U.S. and Europe.

While the U.S. has shown positive growth in GDP, especially in service industries, Europe has faced considerable weakness, including a contraction in GDP in the third quarter. Economic indicators in the U.S., such as the ISM's Purchasing Managers' Index, showed a positive picture in services but revealed contraction in the industry sector.

As the global economic landscape continues to evolve, Israel and the world at large remain in a state of uncertainty, with governments and central banks closely monitoring the situation and making necessary adjustments to their policies.