Israel’s economy faces war on stronger foundations than anticipated

War usually imposes its own financial logic. Growth assumptions are marked down, fiscal cushions thin out, and investors demand a higher price for uncertainty. And Israel’s confrontation with Iran has brought precisely that mix of risks. However, rather than a disorderly retreat, the response of both the economy and its capital markets has been notably resilient, with investors proving more willing than expected to look through the immediate shock. 

The scale of the damage is not in doubt. Israel’s Finance Ministry has estimated that the war could cost roughly NIS 10 billion a week under emergency conditions, reflecting lost business activity, reserve mobilisation and broader operational disruption. It has also suggested that growth could be reduced by around half a percentage point. The Bank of Israel, however, has cautioned that the impact on activity may prove more severe, noting that the operation remains ongoing and that global uncertainty has intensified, driven in part by volatility in energy markets and developments across the international arena.

That deterioration in the fiscal outlook is serious, but it is not yet the whole story. Before this round of fighting, Israel entered 2026 from a position that was stronger than many outsiders appreciated. The Bank of Israel’s January forecast, published after the October 2025 ceasefire, had assumed an expansion in activity supported by lower geopolitical uncertainty, returning reservists and a gradual easing of supply constraints. Israeli markets began this war with the shekel near a 30-year high and with sufficient investor appetite for the finance ministry to raise NIS 3.3 billion in local bond markets against a demand of roughly NIS 20 billion, including participation from major foreign banks. In other words, the country entered the crisis with financial credibility still largely intact.

The more immediate policy response to the current conflict has therefore focused less on macro stimulus than on preserving financial plumbing and household liquidity. The banking supervisor at the Bank of Israel quickly introduced an emergency relief framework for people and businesses directly hit from February 28 onwards, including three-month deferrals on first-home mortgages, consumer credit up to NIS 100,000 and small-business credit up to NIS 2 million, alongside regulatory easing for banks. The logic is familiar from earlier wartime episodes: when mobility is restricted and incomes are interrupted, preserving cash flow can prevent a temporary shock from hardening into a solvency problem.

Yet the risks facing the economy are not confined to domestic disruption. As the conflict has broadened, downside pressures have become increasingly tied to developments in global energy markets. On March 19, Brent crude rose above $115 a barrel following Iran's regime attacks on Gulf energy assets, while European gas prices surged. At the same time, Energean, a gas producer focused on the eastern Mediterranean, suspended its 2026 Israel outlook after conflict-related shutdowns of offshore production, underscoring the vulnerability of regional energy infrastructure. 

For Israel, the risk is less about direct exposure to oil imports alone. Despite its substantial natural gas reserves, the economy remains sensitive to global oil dynamics, particularly through fuel and transportation expenses. A sustained rise in oil – and, by extension, petrol – prices could feed into broader inflationary pressures, reversing part of the disinflation achieved over the past year. That, in turn, complicates the monetary outlook, delaying the path toward lower interest rates. The Bank of Israel’s policy rate remains at 4%, and the combination of renewed energy pressures and rising inflation expectations suggests that the pace of easing is likely to be more gradual than previously anticipated.

Yet here lies the more notable surprise. Israel’s capital markets have not behaved like those of an economy sliding into financial distress. On the first trading day following the strikes carried out by US and Israeli air forces, the reaction was not one of panic but of repricing in the opposite direction: the blue-chip TA-35 index rose 4.6%, while the broader TA-125 gained 4.8%. The move, led by banks, defence and energy stocks, reflected not a dismissal of risk but a reassessment of its scope and duration, while the shekel appreciated 1.5% against the dollar. 

It appears that the economic shock, while severe in headline terms, has so far proved less disruptive than initially feared. This partly reflects a growing institutional and corporate ability to operate under prolonged security pressures – an adjustment shaped by earlier phases of the conflict. Markets, for their part, had already incorporated a substantial geopolitical risk premium in preceding months. More importantly, recent price action suggests a deeper judgment: that while the conflict may weigh on near-term activity, it does not fundamentally impair the long-term earnings capacity of Israel’s leading companies.

That resilience, however, should not be mistaken for immunity. The optimistic case still rests on a crucial assumption: that the war remains containable in economic terms even if it continues militarily. A longer campaign would mean a wider deficit, more pressure on labour supply through reserve duty, and a greater risk that high energy prices seep into a broader inflation problem. That is why the better reading of Israeli market strength is not that investors see no danger, but that they still distinguish between disruption and lasting impairment.

For now, the economy is managing to absorb a severe shock. Whether it can keep doing so will depend less on battlefield headlines than on fiscal discipline, energy stability and the ability of policymakers to stop a liquidity squeeze from becoming a growth shock.