(Reuters) - Credit ratings agency Fitch downgraded Israel's credit rating to "A" from "A-plus" on Monday, citing worsening geopolitical risks as the war in Gaza drags on, and kept the rating outlook negative, meaning a further downgrade is possible.

The ratings agency expects the Israeli government to permanently increase military spending by close to 1.5% of GDP versus pre-war levels, putting upward pressure on the country's budget deficit and debt levels. 

"In our view, the conflict in Gaza could last well into 2025 and there are risks of it broadening to other fronts," the ratings agency said in a statement.

Prime Minister Benjamin Netanyahu said he expected the rating would be upgraded again once Israel wins the war.

"Israel's economy is strong and is functioning very well. The rating downgrade is a result of Israel dealing with a multi-front war forced upon it," Netanyahu said in a statement.

Israel's war in Gaza, triggered by the Islamist group Hamas-led cross-border attack on Oct. 7, has cost thousands of lives and is in danger of expanding.

Earlier this year, Moody's (NYSE:MCO) and S&P Global also cut their credit rating for Israel, citing elevated geopolitical risks.

Fears that the conflict in Gaza could turn into a broader Middle East war have escalated after the killing of Hamas leader Ismail Haniyeh in Iran and top Hezbollah military commander Fuad Shukr in Beirut. Israel is braced for significant attacks from Iran and Hezbollah in Lebanon.

"The downgrade following the war and the geopolitical risks it creates is natural," Israeli Finance Minister Bezalel Smotrich said on X.

Israel's shekel fell as much as 1.7% against the dollar on Monday and stocks ended over 1% lower in Tel Aviv as investors fret over a possible attack on Israel. The shekel opened 0.3% higher on Tuesday while the stock market is closed for a Jewish fast day.

Heightened tensions between Israel and Iran and its allies could imply significant additional military spending, destruction of infrastructure and damage to economic activity and investment, Fitch said.

"Public finances have been hit and we project a budget deficit of 7.8% of GDP in 2024 and debt to remain above to 70% of GDP in the medium term," Fitch said.

Israel's budget deficit reached 8.1% of GDP in July but Smotrich has expressed confidence it will move back towards its 6.6% target for 2024 by year end.

Yali Rothenberg, the finance ministry's top accountant, said Israel's economy was strong and the country still had access to global capital markets but called for a 2025 state budget that would rebuild fiscal reserves through a gradual decrease in the debt to GDP ratio.

Preliminary discussions on the 2025 state budget have already begun. Smotrich said a responsible budget would be approved that would support the war while maintaining fiscal frameworks. "Very quickly, the ratings will rise again," he said.