ANALYSIS-Settlements row with U.S. may cloud Israeli economy

* Settlements row could threaten U.S. fiscal support

* Loan guarantees, defence aid potential targets

* Netanyahu likely to put economy first-analysts



By Dan Williams

TEL AVIV, June 7 (Reuters) - Israel's economy, unscathed by costly wars in Lebanon and Gaza, faces a new challenge, this time from an ally -- the United States.

Differences with U.S. President Barack Obama over Jewish settlement of occupied West Bank land that Palestinians want for a state has some experts predicting a price in terms of U.S. fiscal support and investment for Israel.

Some diplomats say Washington could eventually reconsider Israel's receipt of hefty U.S. loan guarantees or $3 billion in annual defence aid. That would scare off foreign investors seeking a buffer against Middle East instability.

There are also signs the European Union, Israel's biggest export market, could follow the American lead by making a concerted push to prevent products from settlements from receiving tax privileges within the 27-nation bloc.

Though marginal, settler products could harm Israeli exports as a whole by forcing an overhaul of labelling practices. European clients may wonder if Israel is worth the hassle.

But any changes in U.S. policy are unlikely to come soon.

Obama must contend with pro-Israel backing in Congress, and Israeli Prime Minister Benjamin Netanyahu could pre-empt a confrontation by changing the make-up or peace policies of his right-leaning coalition government.



CONFIDENCE

But experts say that merely the idea of waning U.S. support risks shaking confidence in an Israeli economy which banks on international trade.

Michael Sarel, head of economic research at Harel Insurance Investments, noted credit rating reports on Israel regularly cite its perceived U.S. economic "cushion".

After Palestinian suicide bombings in 2002 gutted tourism to Israel, the United States intervened with a pledge of $9 billion in loan guarantees. It gave Israel another $1 billion to help prepare for any fallout from the 2003 U.S. invasion of Iraq.

That shored up the Israeli economy, which coasted through the 2006 Lebanon war and last December's Gaza Strip offensive: The Tel Aviv Stock Exchange's TA-100 index has increased by 31 percent this year and the shekel is stronger against the dollar.

"If U.S. support is perceived to have been eroded, that would be reflected in the rating, risk premiums and long-term interest for government bonds," said Sarel, who played down the prospect of concrete Western economic action against Israel.

HSBC economist Jonathan Katz was similarly sceptical but allowed that "investors have been asking questions" about Israeli risk given the dispute with the Obama administration.

He said any instability in Israel would be a compound outcome of several factors, including the international financial woes and speculation about a possible Israeli war with Iran. The latter scenario, however, would likely make the United States close ranks with its Israeli ally.

Katz saw Netanyahu, a former finance minister praised for his free-market reforms, folding on the diplomatic front before a serious economic crisis could evolve.

"He will do what it takes to resolve the situation, even if it means switching (coalition) partners," Katz said. (Editing by Tova Cohen and Janet Lawrence) (For blogs and links on Israeli politics and other Israeli and Palestinian news, go to blogs.reuters.com/axismundi)