EU may take action against Israel if conditions in Gaza do not improve

The EU is poised to consider "further measures" against Israel, including potential actions related to their €68bn trade and cooperation pact, following findings of human rights breaches in Gaza and the West Bank. EU foreign policy chief Kaja Kallas indicated discussions on these measures could occur in July if the situation doesn't improve, while 17 member states have already triggered a review of the association agreement. Despite calls from Spain for outright suspension, significant internal divisions persist within the bloc, with Germany, Italy, and Hungary opposing such drastic steps, underscoring the complex economic and political implications for the substantial bilateral relationship.

Analysis

The European Union is signaling a potential escalation of pressure on Israel, leveraging the €68bn EU-Israel association agreement over findings of human rights breaches in Gaza and the West Bank. The activation of a review by 17 member states and the prospect of discussing "further measures" in July introduces a material risk to the bilateral relationship, particularly as the EU represents approximately one-third of Israel's export market. However, the threat is tempered by significant internal division within the bloc. While nations like Spain, France, and Belgium advocate for punitive action, including a potential suspension of the agreement, key members such as Germany, Italy, and Hungary remain opposed. This disunity makes a full, unanimous suspension improbable in the near term. Nevertheless, the possibility of a weighted majority vote to suspend specific components, such as trade privileges or participation in the Horizon research programme, remains a credible and impactful threat, creating a period of heightened uncertainty for Israeli assets and sectors with high exposure to the European market.

Key Decisions for Investors

• Investors should closely monitor the EU foreign ministers' meeting in July, as any decision to implement 'further measures' against Israel could materially impact the €68bn trade relationship.
• A review of portfolio exposure to Israeli sectors heavily reliant on EU exports, such as technology and specialized manufacturing, is warranted, as these areas face the highest political and economic risk from a potential partial suspension of the trade agreement.
• Given the significant geopolitical uncertainty and 'strongly negative' sentiment, it may be prudent to consider hedging strategies for Israeli Shekel (ILS) exposure, as the currency is vulnerable to downward pressure from escalating diplomatic and trade tensions with its largest trading partner.