The domestic and external threats facing Israel continue to mount. The Obama administration has clearly signalled that it intends to be less consistently helpful to Israel than the Bush administration, with a greater emphasis on the welfare of the Palestinians and on improving relations with Muslim countries.

The philosophical divide between Israel’s right-wing Prime Minister Benjamin Netanyahu and the liberal US President Barack Obama adds a further complication.

Netanyahu has finally signalled his acceptance of a two-state solution to the Palestinian problem, but we remain unconvinced that this gesture is as far-reaching as some have perceived it to be. While the phrase 'two-state solution' is now firmly on the negotiating table, we see little movement or compromise on almost every other issue – most notably West Bank settlements and the right of return – that still separates the Israeli and Palestinian positions. The hostile Palestinian response to the prime minister’s words illustrated the gulf that continues to divide the two sides.

Israel’s defence industry is one of the stalwarts of the national economy, benefiting from the Israeli military’s hefty requirement for sophisticated armaments. At a political level, however, debate continues over whether Israel is devoting too many resources to maintaining its military might, especially given the global economic turmoil.

That said, there are some encouraging data emerging from the macro-economy. Real GDP expanded by 1.0% year-on-year (y-o-y) in the second quarter, following a 3.2% contraction in Q1 (revised down from an earlier estimate of 3.6%). When seen against the backdrop of improving trade data, buoyant inflation and a strengthening currency, the latest figures add to our view that Israel is set to make a fairly quick recovery from what has been, by global standards, a fairly short recession.

However, we still see real GDP contracting over 2009 as a whole. Our forecast is now for a contraction of 1.9%. This reflects our caution on the prospects for some of last quarter's key growth drivers, most notably exports and private consumption.

In Q309, the updated the methodology of its Terrorism Rating and expanded it to cover 170 global cities, as well as 130 states. As before, the Terrorism Rating incorporates our analysts’ qualitative view of the terrorist threat. However, it also incorporates secondary analysis of data on global terrorist incidents obtained from the US State Department’s Worldwide Incidents Tracking System, to provide a quantitative assessment of the risks.