Shekel gains brief respite

Renewed violence has cost the economy dear

Israel's currency, the shekel, has stabilised on the foreign exchanges after hovering close to record lows against the dollar following the deteriorating security situation.

Last week, the shekel sank to levels not seen in more than a decade as security concerns grew, and worries intensified about the impact on an already stretched budget of more defence spending.

On Wednesday things had improved slightly, with the currency creeping back from the low of almost 4.80 shekels to the dollar.

But traders and economists fear that without some concrete shift in the positions of both the Israeli government and the Palestinians, the drift lower is likely to continue.

Confidence shock

"The fundamental story (for the shekel) is still fairly solid," said Timothy Ash, emerging markets economist at Bear Stearns in London.

The occupation of the West Bank leaves commerce at a standstill

"There are a lot of (economic) positives in Israel, and if the situation were improved one could see a return to strong growth," he told BBC News Online.

"But the story is political here, and the political instability is delivering a confidence shock. I can't see the shekel recovering till things get much quieter."

The falling currency places yet more stress on the already weakened Israeli economy.

"It means higher inflation, the likelihood of more interest rate hikes - the Central Bank has made that absolutely apparent - and therefore lower growth," Mr Ash said.

From boom to bust

Until the end of 2000, Israel's economy was thriving, with its hi-tech sector helping to drive growth to more than 6%, inflation staying within bounds, unemployment relatively low and the Central Bank keen to keep interest rates down as well.

That all changed in 2001, as escalating tensions between Israel and the Palestinians and the global slowdown combined to eat into the economy.

Growth turned negative, and the budget deficit spiralled out of control. This year it could reach 5-6% of gross domestic product.

Part of the increase was due to sharply increased defence spending.

But most of it stemmed from demands by hard-line religious parties for increased spending on welfare for their own constituencies.