People sit at an outdoor restaurant where Israeli flags are displayed, amid the ongoing conflict between Hamas and Israel, in Tel Aviv, Israel, July 12, 2024. REUTERS/Eloisa Lopez

Israel’s economy began 2026 with a slowdown, hit by war with Iran, but growth is expected to recover as long as the conflict does not reignite.

Gross domestic product contracted at an annualized rate of 3.3 percent in the first three months of 2026, the Central Bureau of Statistics said on Sunday, less severe than a 4 percent drop forecast in a Reuters poll of economists.

Israel’s economy grew 2.9 percent in 2025 and was expected to bounce back in 2026 to more than 5 percent growth after a ceasefire in October ended major fighting in the two-year Gaza war.

But growth took a hit after the US and Israel launched strikes against Iran on February 28, resulting in weeks of ballistic missile fire from Iran that closed schools and dampened business activity along with consumer spending.

“The Israeli economy began the year with strong momentum, with rapid growth in the first two months,” said Ofer Klein, head of economics and research at Harel Insurance and Finance.

“The lifting of most restrictions in April and the improvement in economic activity since then… indicate a relatively quick return to positive growth in the current quarter,” said Klein, who raised his growth estimate for this year to 3.5 percent from 3.2 percent.

The Bank of Israel sees 3.8 percent growth this year, down from a 5.2 percent estimate before the Iran war, depending on whether a ceasefire with Iran holds.

Jonathan Katz, chief economist at Leader Capital Markets, said he expected 4 percent growth.

“This is a modest GDP contraction compared to the second quarter of 2025 – the last Iran confrontation in June of 2025 – when GDP contracted by over 10 percent,” he said, adding that industrial exports bounced back in April.

The statistics bureau reported on Friday that the annual inflation rate held steady at 1.9 percent in April. Some economists believe interest rate reductions could resume as early as May 25, the Bank of Israel’s next rate decision meeting.

Israeli financial markets do not trade on Sunday. The shekel has appreciated 20 percent in the past year to 2.91 per dollar, a 33-year high. Tel Aviv share indices are close to all-time highs reached earlier in May.

In the first quarter, consumer spending fell 4.7 percent, exports declined 3.7 percent and government spending shed 4.8 percent. Investment in fixed assets rose 12.6 percent.

On a per capita basis, the economy shrank 4.5 percent in the quarter.