Jan. 8 (Bloomberg) -- Israeli stocks and the shekel fell after rockets fired from Lebanon struck northern Israel, raising concern the conflict with Hamas in the southern Gaza Strip will expand to other borders.

Bank Leumi Le-Israel Ltd. and Bank Hapoalim Ltd., Israel’s largest banks, led the decline. Israel Chemicals Ltd., which extracts minerals from the Dead Sea to make fertilizers, dropped on a slide in commodities. The shekel lost as much as 1.3 percent against the dollar to 3.9315, the lowest in almost a month.

“Investors are wary of the possibility of an escalation and possible fighting on two fronts, which could then bring the markets further down here,” said Itamar Casif, head of capital market research at First International Bank of Israel Ltd., the country’s fifth-largest lender.

The benchmark TA-25 Index dropped the most in three weeks, retreating 17.44, or 2.5 percent, to 677.14. The measure has gained 6.7 percent since Dec. 27 when Israel began its campaign against Hamas in the Gaza Strip, tracking a global rally. The index gained 1.5 percent this week.

The rockets hit western Galilee, in northern Israel, close to the border with Lebanon, slightly injuring two people and leaving several others needing treatment for shock, police said. Israeli artillery bombarded southern Lebanon in response, Israel’s Channel 2 reported.

The yield on the benchmark Mimshal Shiklit notes was unchanged at 5.1 percent. The 5.5 percent securities due February 2017 retreated less than 0.1 shekel to 107.20. Bond yields move inversely to prices. The Mimshal Shiklit and the Shahar government bonds account for about 60 percent of domestic debt traded on the Tel Aviv Stock Exchange, and Galil inflation- protected notes make up about 40 percent, according to the Finance Ministry.

‘Cease-Fire’

Hezbollah wasn’t involved in the rocket attack on Israel, said Ali Hamdan, a spokesman for Lebanese Parliament Speaker Nabih Berri.

The attacks came as an Israeli delegation headed to Cairo to discuss a French-Egyptian proposal that would end military operations against Hamas in Gaza during the 13th day of the conflict.

“The situation is still under control and the general sentiment is that a cease-fire may not be too far away,” First International’s Casif said.

Bank Leumi, Israel’s largest bank by market value, fell 0.40 shekel, or 4.4 percent, to 8.60. Bank Hapoalim, the country’s second-largest, retreated 0.33 shekel, or 3.7 percent, to 8.52.

Africa Israel Investments Ltd. slid 2.49 shekels, or 6.7 percent, to 34.51. The real-estate investment company controlled by diamond billionaire Lev Leviev has a net asset value, its underlying assets minus liabilities, of zero, Clal Finance Ltd. said.

Global Markets

A decline in global stock markets today accounted for about half of the drop in Israel, said Avi Weinreb, a Tel Aviv-based trader at Clal Finance Batucha Investment Management Ltd.

Shares in Europe and Asia fell on speculation earnings will deteriorate as weakening demand for commodities drives down metals and oil prices.

Egypt’s benchmark stock index, the CASE 30 Index, fell the most in almost three weeks, dropping 1.6 percent to 4,634.36.

The military offensive and the global credit crisis don’t presently threaten Israel’s A1 credit rating, Moody’s Investors Service said in a report yesterday.

“Our main concern for the credit rating is fiscal, given the unknowns over the cost of the military conflict with Hamas in Gaza,” said Joan Feldbaum-Vidra, Moody’s New York-based analyst for Israel.

To contact the reporter on this story: Tal Barak Harif in Tel Aviv at tbarak@bloomberg.net; David Wainer in Jerusalem at dwainer@bloomberg.net

Last Updated: January 8, 2009 10:45 EST