Modest recovery faces internal and external challenges

ISRAEL - Report 29 Apr 2025 by Sani Ziv

Israel’s economy continued to expand in the first quarter of 2025, although the level of activity remained below its potential trajectory. Despite the ongoing recovery, the economy has clearly not yet returned to full productive capacity.

On the geopolitical front, the overall risk environment for 2025 remains significantly lower compared to 2024. However, risks have increased relative to the fourth-quarter assessment, following the ceasefire agreements in Lebanon and Gaza reached then. In the south, the probability of a prolonged period of conflict at varying intensity without a stable settlement has risen. In the north, the ceasefire with Lebanon continues to hold, with the Lebanese government demonstrating commitment to maintaining it, alongside early signs of political discussions that could potentially lead to the dismantling of Hezbollah’s military capabilities. Regarding Iran, negotiations with Washington are ongoing, with a reasonable chance of positive progress. However, the risk of a breakdown in talks and a potential confrontation between Israel and Iran still remains.

Global risks have also intensified. The renewed trade war, triggered by U.S. tariff hikes, has introduced exceptional volatility in global financial markets and increased uncertainty regarding global growth prospects. Although Israel’s direct exposure to U.S. tariff policy is relatively limited, a broader global slowdown—reflected in most growth forecasts for 2025-2026—is expected to impact the Israeli economy, as well.

Domestically, political uncertainty continues to mount, particularly amid ongoing controversial legislative efforts concerning governance and the judicial system. These could weigh on Israel’s attractiveness to foreign investors and potentially impact the country’s sovereign credit ratings.

All these factors are reflected in financial market indicators: Israel’s risk premium has risen from 119 basis points at the beginning of the year to around 140 basis points currently. While still significantly below the October 2024 peak of 190 basis points, the premium remains well above its pre-war level of 68 basis points.

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