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After another day in which the Tel Aviv Stock Exchange gained ground, the TA-100 index yesterday hit its highest point in almost two years. The index of Israel's 100 highest market capitalizations closed the trading day yesterday at 462 points, three points above its late June record and just 2 percent below the January 2002 record that followed on the heels of Bank of Israel's dramatic 2 percent rate cut.

The bond market is also seeing records. After relatively sharp gains in recent days on the back of September's surprisingly low consumer price index, annual yield on long-term shekel bonds fell to 7.5 percent, three percentage points below prevalent yields in June and July 2003.

Despite the peak level of the TA-100, not all financial market parameters indicate improvement over the summer months. For instance, the Maof-25 blue chip index - the 25 largest publicly-traded companies - is 2 percent below its June peak. The shekel is also far weaker than it was in early July, when the representative dollar exchange rate was NIS 4.28. Yesterday the dollar continued to gain ground in local trading, closing a 4 percent gain since then with the official daily rate set at NIS 4.463.

In those late June days, the geopolitical atmosphere was substantially different. The government was negotiating with former Palestinian prime minister Mahmoud Abbas on the implementation of the road map, security responsibility for Palestinian cities was transferred one after the other to the Palestinian Authority, and pictures of columns of Israeli flag-draped tanks heading out of Gaza made the front pages of all the major newspapers.

With the collapse of the cease-fire and the return of terror attacks and retaliatory operations (surgically-precise, of course), financial market players expected stocks and the shekel to fall. In fact, in two months, TASE indices lost 10 percent, bond yields rose and the shekel slid.

However, since the end of August, despite the serious aggravation of the security situation in recent weeks, optimism has returned to financial markets, which are taking their lead from improved financial situation and fiscal policy.

The strength of the financial markets stems mostly from relatively low Bank of Israel interest rates, which are expected to drop even further, as inflation expectations drop. Market players see 5 percent interest within a month and believe this is the interest level for the resumption of growth.

Additional optimism is attributed to the Finance Ministry's determination to see the 2004 state budget ratified and in its political battles. Markets are also riding the tailwind from global markets, mostly substantial gains on Wall Street.