Gaza war is proving costlier than expected, Bank of Israel governor says

Debt-to-GDP ratio is expected to rise more than 65% by the end of the year

Israel's Iron Dome air defence system fires missiles to intercept a rocket fired from the Gaza Strip. Israel is expected to record lower growth this year amid war with Gaza. AP

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Israel’s war with Hamas is proving costlier than initially estimated and has been a “major shock” to the country’s economy, with growth expected to fall in 2023 and 2024, Bank of Israel governor Amir Yaron has said.

While Israel’s economy is strong and stable, “there is no doubt the war will have fiscal implications and generate budget pressures”, Mr Yaron told a conference hosted by the International Monetary Fund in Washington on Thursday.

Its economy is bearing the brunt of the war as the pace of economic expansion is expected to slow significantly this year and the next, while the debt-to-gross domestic product ratio is set to climb.

GDP growth is set to be lower by 1 per cent in 2023 and 2024 while “the debt-to-GDP ratio is likely to rise somewhat more than 65 per cent by the end of 2024, as costs are larger than it was initially projected”, Bloomberg cited Mr Yaron as saying.

These estimates are based on the assumption that the Israel-Gaza war remains concentrated near the southern border and lasts through to the end of this year, he said.

Israel’s war with Gaza has entered its fifth week, with Prime Minister Benjamin Netanyahu's government continuing to bomb the narrow Palestinian enclave, killing thousands of people and destroying its fragile economy.

The war began on October 7 when Hamas operatives attacked southern Israel, killing about 1,400 people and taking about 240 hostages.

Israel retaliated with air strikes and its continued bombardment of Gaza has turned into a humanitarian crisis as the Palestinian death toll has risen to about 11,000.

S&P lowered Israel’s credit outlook to negative, from stable, citing the risk that the conflict could broaden, with a more pronounced effect on the country's economy.

Last month, Moody's placed the government of Israel's “A1" long-term foreign currency and local currency issuer ratings on review for downgrade. Previously, the outlook was stable.

It expects a prolonged conflict waged on several fronts to have a severe and lasting impact on Israel’s economy.

Israel’s central bank has cut its economic forecasts since the war with Hamas began. At its last rate meeting on October 23, the bank said GDP would probably grow by 2.3 per cent in 2023 and 2.8 per cent in 2024, down from its previous projection of 3 per cent for this year and the next.

US bank JP Morgan estimates that Israel’s seasonally adjusted GDP could shrink by 11 per cent, quarter on quarter, in the last three months of the year.

The lender’s estimates are among the most pessimistic from Wall Street analysts so far.

The Bank of Israel also held its key interest rate at 4.75 per cent, avoiding a cut in an attempt to support the shekel.

The currency, as well as Israeli stocks and bonds, fell heavily when the war erupted but have recovered over the past 10 days, with the shekel recouping all its losses.

That is partly because of a support package – the central bank sold more than $8 billion of reserves – and increased optimism among traders that the war will more or less be restricted to Gaza, according to Bloomberg.

The shekel dropped to a near eight-year low against the US dollar two days after war broke out between Israel and Gaza.

So far, the Bank of Israel’s steps have mitigated fluctuations in the shekel and have provided liquidity and stability to financial markets, Mr Yaron said.

“This array of policy steps that were taken by the bank in the last month reveals the sufficient and necessary independence that the bank enjoys and that it has the adequate set of monetary tools that can ensure financial stability.”