Foreign residents did not realize their investments but increased their direct activities in Israel in an adverse reaction to the security shock.
"Not only did non-residents not show net realization of their investments, they actually continued to increase their direct investments in Israel," said the Bank of Israel in a discussion report preceding the interest-rate decision for September 2006, when interest rates remained steady at 5.5 percent.
"Households, unlike their sharp reaction under similar circumstances in the past, did not respond to the security shock by buying significant amounts of foreign currency," the report said.
According to the the Bank of Israel's August data, foreign investment in Israel totaled $480 million during the war period between July 12 and August 14, while foreign investment totaled $358m. during the month of August.
The positive interest-rate differential between the Bank of Israel and the US Federal Reserve, which stood at 0.25 percentage points, was attributed to the stability of the shekel. With regard to the Bank of Israel interest rate, data from the capital market (the makam curve) indicated that the rate was expected to remain steady.
"Some private economic forecasters do not expect the rate to change in the next few months, and others expect a change of 25 basis points by the end of 2006," the report said.
The Bank of Israel forecasted that the major negative economic effect of the hostilities in the North on the country's growth would not continue beyond the third quarter of this year.
"The revised growth forecast for 2006 stands at 4.5%, compared to 5.5% before the fighting," the central bank said. "The fall in the growth rate is expected to be only temporary, with some of the losses in manufacturing, commerce and services being recouped by the end of the year."
The bank said the budget deficit was expected to be approximately 2% of GDP, assuming the fighting in Lebanon would result in a 1% loss of GDP in 2006.
Concerns were raised in the discussion report over the increased uncertainty regarding the growth and size of government expenditures and the expected changes in the state budget for 2007, and the difference between one-off expenses and those that might be adopted as part of the budget in coming years.
Still, the Bank of Israel concluded that because of the temporary economic effect of the fighting and the robustness of the financial markets, the repercussions would not have a significant effect on prices.
"Assessments regarding the absence of a significant change in aggregate demand, together with the limited and temporary impact on supply, leads to the conclusion that the fighting is not expected to have much impact on price development," the report said.