The Israel-Hamas War: Risks of Spillover in the Region and Beyond

Bradley Intelligence Report

Client Alert

Author(s) Dan Arbell (Associate Fellow, International Institute for Strategic Studies)

Sixteen days after the Hamas attack on Israel and Israel’s declaration of war, Israel is preparing to launch a major ground operation into the Gaza Strip with the stated goal of eradicating Hamas. With casualties on both sides continuing to rise – over 1,400 Israelis and 3,000 Palestinians have died thus far – thousands more injured or displaced, and over 200 hostages held somewhere in Gaza, international attention is focused on the immediate security situation in the conflict area and managing the risks of spillover in the region and beyond.

The U.S. Response

As a key indicator of the level of U.S. concern that the current fighting could escalate, the Biden administration leaned in forcefully in a way that has not been seen in the Levant since the October 1973 war. Recognizing that the Hamas attack may lead to the opening of a second front (between Israel and Hezbollah) and perhaps a third front in the West Bank, President Joe Biden immediately and clearly stated that the U.S. stands firmly with Israel, supports its “right and duty” to defend itself, and prioritizes the release of the hostages held by Hamas, while pledging to assist militarily in whatever way Israel needs. The White House announced an additional $1.4 billion in U.S. military aid to Israel as part of the $100 billion in supplemental funds it requested from Congress on Oct. 20.

The president sent a clear warning to Iran and Hezbollah not to take advantage of the situation and attack Israel, announcing that he is ordering the deployment of the USS Gerald R. Ford Carrier Strike Group (CSG) – the U.S.’s newest and largest aircraft carrier – to the Eastern Mediterranean. Several days later, U.S. Secretary of Defense Lloyd Austin ordered a second CSG, the Dwight E. Eisenhower, to begin moving to the Eastern Mediterranean. Subsequently, the Pentagon announced the dispatch of a U.S. Marine Rapid Response Force, consisting of 2,000 Marines and sailors, to the waters off the Israeli coast, in contingency for a potential deployment to the country.

The U.S. is working behind the scenes with Qatar, Egypt, Turkey and the UN in an effort to bring the release of as many hostages as possible and is asking Israel to postpone its ground entry into Gaza until more hostages are released. At the same time, the U.S. is focused on the humanitarian crisis in the Gaza Strip, which has worsened as a result of Israel’s aerial attacks. The administration has appointed a special envoy for humanitarian issues and has been working with Arab nations and Israel to create a humanitarian corridor and mechanism to provide humanitarian assistance to the people of Gaza. 

The U.S. is also working to reassure Palestinian Authority (PA) President Mahmud Abbas of its support, announcing a $100 million assistance package and continuing to state America’s commitment to a two-state solution.

Potential Flashpoints

The U.S. and other members of the G-7 are coordinating their efforts and are engaging Arab states and other international and regional actors in an effort to prevent the spillover of the Israel-Hamas conflict to other arenas, mainly Lebanon and the West Bank.

While Israel’s ground offensive in Gaza has not yet started, a low intensity conflict is developing on Israel’s northern front. Border skirmishes are taking place between Iranian-backed Hezbollah, Hamas-affiliated militias, and the Israel Defense Forces (IDF). Hezbollah has warned it will launch an attack on Israel if the IDF enters Gaza. Israeli Minister of Defense Yoav Gallant is messaging that Israel does not want a war with Hezbollah, but if attacked will not hesitate to engage in a war.

Currently, all parties appear to be avoiding escalation. However, miscalculations and provocations could lead to uncontrolled escalation and a full-scale war between the two sides, which would amount to a repetition of the 2006 war, only with much greater fire power and, consequently, casualties. In this context, much will depend on Iran’s intentions, as Hezbollah receives its marching orders from Tehran. At present Iran does not seem to want a confrontation; however, if attacked by Israel, the Iranian regime may reconsider its position.

The situation in the West Bank is very tense, but at present it remains under control. That said, conflict between Israeli settlers and West Bank Palestinians prior to the Hamas attack could reignite with new zeal. U.S. and European leaders are signaling to the Israeli government they expect no changes in the status quo in the West Bank, emphasizing that if settlers try to create new realities on the ground there while Israel is fighting Hamas in Gaza, there would be serious consequences.

Anger and frustrations are running high across the Arab world in response to the war, with images of Palestinian casualties and displacement flooding Arab media. Arab leaders condemned Israel’s decision to cut off electricity, water and fuel to Gaza and prohibit immediate humanitarian assistance. Against the backdrop of protests in solidarity with the Palestinians and against Israel in most capitals around the Arab world, Arab leaders convened in Cairo over the weekend for an emergency summit to discuss their next steps. In recognition that the humanitarian crisis is fuel to the flames, U.S., European and Arab leaders are emphasizing the need to protect innocent civilians and allow humanitarian assistance into Gaza.

Longer Term Risks

The Israel-Hamas war may continue for a long period – several more weeks if not months. The war has already led to the suspension of talks between the U.S., Saudi Arabia and Israel on a Saudi-Israeli normalization. The fighting will have a chilling effect on the Arab signatories of the Abraham Accords, but these agreements are likely to hold over the long term because they are in the political and economic interests of the parties. The newly inked India-Middle East-Europe Economic Corridor agreement will likely see planning delays, if not a dent in the enthusiasm of support, as will efforts under the umbrella of I2U2, an agreement signed by Israel, India, the UAE and the U.S. in 2022 to boost private sector cooperation.

The impact on the economies of countries in the region is so far limited, except for Israel and the Palestinians territories. After a tough year due to the Israeli government’s judicial overhaul plan, which has slowed down the Israeli economy (foreign direct investments dropped significantly in the first half of 2023), the economy is taking more hits as a result of the war. As the war continues, with tens of thousands displaced and hundreds of thousands of Israelis mobilized for reserve duty, businesses are already downsizing, cutting costs, and firing employees. This trend is expected to continue as long as the war does. The Israeli shekel has weakened in recent months and dropped further as a result of the war, now trading at 4.05 shekels to the U.S. dollar. The interest rate remains high at 4.75% and will likely rise if the war continues. The Israeli economy was hit hard during COVID-19 but has managed to bounce back. Currently, it may be able to sustain itself, but an escalation of the war and the opening of other fronts may lead to the deepening of negative economic trends.

The Palestinian economy has also been strongly impacted, and the PA’s economic growth (which had already slowed down prior to Oct. 7) will continue to decline as a result of the war. The war has wrought havoc in the Gazan economy, and it is expected to further deteriorate in the coming weeks. An intensification of the conflict in Gaza and the opening of more fronts would present serious economic challenges to neighboring countries such as Egypt, Jordan and Lebanon.

Oil markets have recovered from the initial shock, but will remain vulnerable to additional shocks, should the conflict expand. Should Iran decide to put pressure on Israel and the U.S., Tehran could resume harassing shipping through Gulf waters, threatening global energy security. The oil market is already tight, with sanctions on Russia, the oil price cap and OPEC+’s policy constraining production, and concerns over shipment security would threaten supply and boost prices.

The International Monetary Fund has also warned that the Israel-Hamas war could add to economic headwinds, including the slowdown in China and the impacts of climate change. The risk is the jump in oil prices that could feed core inflation, induce central banks to resume increasing interest rates, and prolong the fight against inflation. Despite being physically constrained to a small area in the Levant, the ongoing Israel-Hamas conflict has already impacted global markets to an extent – an effect that will only increase if violence escalates and spreads.

*Dan Arbell is a guest author and is not an employee of Bradley.