(Repeats to clarify that the losses referred to in paragraph 4 were earlier today)

By Steven Scheer

JERUSALEM, May 1 (Reuters) - Scathing criticism by Israel's Lebanon war inquiry may have weakened Prime Minister Ehud Olmert politically but investors do not seem concerned as long as the economy remains strong and companies reap profits.

A government-appointed panel on Monday cited a list of failures in Olmert's handling of the 34-day war with Hezbollah guerrillas in Lebanon last year.

It stopped short of calling on Olmert to quit but said he and the country's top two defence officials were to blame for launching the war after Hezbollah seized two soldiers without proper planning.

Yet Tel Aviv share indexes, up 15 percent so far in 2007, reversed Tuesday's earlier losses to trade near all-time highs, while the shekel weakened marginally to hold close to a 6-1/2-year against the dollar.

"In a bull market, people tend to ignore bad news and put more emphasis on good news," said Ronen Avigdor, chief executive of the Menora Mivtachim Mutual Funds.

Olmert -- under investigation for several corruption charges which he has denied -- has defied calls to step down. Should he quit, an early election could be called.

But despite the political troubles, and although peace talks with the Palestinians have been frozen for some time, the economy is undeterred and is booming. Growth is expected at about 5 percent in 2007 for a fourth straight year.

"At the end of the day, it's the economy that matters," said Racheli Gershon, head of Bank Hapoalim's research unit. "And we are also seeing good corporate results as well as positive expectations for the coming quarters."

Analysts said the market is not overvalued.

"As long as the international environment is positive and the economy here is strong, I see no reason for the market to change its trend right now," Avigdor said.

SHEKEL RALLY DONE?

Still, analysts expect the shekel's rally to stall for now. Underpinned by the robust economy and the dollar's global weakness, the Israeli currency has gained about 5 percent so far in 2007 after an 8 percent appreciation last year.

Tuesday's official rate of 4.0350 per dollar is very near its strongest since August 2000 when it was at 4.00.

Lucy Bethell, an emerging markets strategist at RBS in London, said that if the current government remains, Olmert and his coalition partners could raise state spending for education and welfare to build up their ratings in opinion polls.

She foresees a consolidation and a slight weakening of the shekel to 4.10 to the dollar based on the political issues.

"Then at that level, people will start to sell dollars," she said. "But I won't be selling dollars at this point."

The market's optimism is due partly to the fact Israel's market has matured greatly since the beginning of the decade when every Palestinian suicide bombing led to steep price declines.

Since the beginning of 2006, markets and the economy have overcome geopolitical problems from the sudden illness of Prime Minister Ariel Sharon, the victory of Hamas militants in Palestinian elections, an Israeli general election and the Lebanon war.

"Any drastic fall in the market creates a buying opportunity," Avigdor said.

Investors in 2007 have shrugged off Olmert's problems and the suspension of Finance Minister Abraham Hirchson, who is battling charges of fraud and embezzlement in a prior job.

Market players say they would be happy with any replacement who continues the current policies of fiscal discipline.

Similarly, they are not too concerned about an early election since former prime minister Benjamin Netanyahu, a market favourite, is a frontrunner to win such a poll.

One potential negative for the markets would be if Bank of Israel Governor Stanley Fischer were to quit, maybe to take the reins at the World Bank if Paul Wolfowitz resigns.

"If he leaves, it would be a negative," Avigdor said. "The mere fact he is governor helps Israel."

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