Israel’s Growth Slows Much More Than Expected as War Drags On

Galit Altstein
·4-min read

(Bloomberg) -- Israel’s economic growth slowed substantially more than expected over the second quarter, as the war against Hamas and tensions with Hezbollah put increasing financial strain on the country.

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Gross domestic product rose by an annualized 1.2% quarter-on-quarter in seasonally adjusted terms, according to preliminary figures published by Israel’s Central Bureau of Statistics on Sunday. Economists had expected growth of 5.9%, according to the median estimate in a Bloomberg survey. The lowest of the eight forecasts was 2.3%.

The economy contracted almost 21% in the fourth quarter of last year after the conflict in Gaza erupted, before recovering somewhat in the first three months of 2024.

The latest figures indicate “the significant damage that the ongoing war is causing to the economy,” said Ronen Menachem, chief markets economist at Mizrahi Tefahot Bank. He cited data showing that GDP per capita shrank an annualized 0.4% in the second quarter.

One of the biggest drivers of the slowdown was exports, which declined for a third consecutive quarter and by 7.1%, excluding diamonds and startup companies. Fixed asset investments also stagnated. Imports, not including defense, ships, aircraft and diamonds, shrank 7.3%.

Much of the slowdown in fixed investments is down to a slump in construction. The industry relies on Palestinian workers from the West Bank, who have been banned from entering Israel since the start of the war. The government has not been able to keep its promise to replace them with other foreign workers.

A spike in government and private consumption did little to offset the slump in exports and investments.

Government consumption surged 8.2% versus 2.6% in the previous quarter, adding to concern that economic growth has become over reliant on high public spending, which is mainly associated with the needs of war.

Israel’s 12-month trailing budget deficit widened to 8.1% of GDP in July. Fitch Ratings downgraded Israel’s sovereign debt rating by one level to A from A+ last week, saying the war in Gaza “could last well into 2025 and there are risks of it broadening to other fronts.”

Fitch projects the fiscal deficit could reach 7.8% this year from 4.1% in 2023, and expects debt to remain above to 70% of GDP in the medium term.

Despite the cooling in economic growth, the Bank of Israel is unlikely to cut its key interest rate from 4.5% at its next such meeting on Aug. 28. Israel has seen its inflation rise continuously in recent months, with the latest reading at 3.2% year-on-year — outside the 1%-3% target range.

“Since the weak growth figures are due to supply and not demand issues, they are not expected to support interest rate cuts, especially against the background of signs of acceleration in inflation in the July index and a high level of geopolitical risks,” said Jonathan Katz, economic strategist at Leader Capital Markets.

The Israeli finance ministry projects growth of 1.9% for 2024, while the country’s central bank has already downgraded its forecast to 1.5%.

“Moving into the second half of the year, it is likely that the economy’s activity will falter,” said Menachem. “The economy is at full employment, the number of job vacancies is increasing. The difficulty in manning positions with professional workers will continue to restrain activity and GDP growth.”

The war broke out after an Oct 7. attack on Israel by Hamas, designated a terrorist organization by the US and the European Union, that saw 1,200 people killed and almost 250 taken hostage. The death toll in Gaza from Israel’s subsequent offensive has now exceeded 40,000, according to the Hamas-run health ministry, which doesn’t distinguish between militants and civilians.

The US is trying to mediate a cease-fire, though Israel and Hamas are blaming each other for stalling the talks.

As well as the conflict in Gaza, Israel is exchanging fire with Hezbollah militants based in Lebanon. Tensions have soared in the past month after Israel assassinated a leading Hezbollah commander in Beirut. The group — which, like Hamas, is backed by Iran — has threatened to retaliate in a major way and may act in coordination with Tehran.

Read this next: Gaza Is Reduced to 42 Million Tonnes of Rubble. Can It Rebuild?

Israel said the Hezbollah commander had organized a rocket attack on a Druze town in the Israeli-controlled Golan Heights that killed 12 children and teenagers playing football.

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