After Golda Meir's resignation, Yitzhak Rabin became Prime Minister of Israel. However, Rabin resigned in April 1977 due to the "Dollar Account affair," involving an illegal U.S. dollar account held by his wife.^[210] Shimon Peres then informally led the Alignment party in the subsequent elections.

The 1977 elections marked a significant shift in Israeli politics, with the Likud party, led by Menachem Begin, winning 43 seats. This victory represented the first time a non-leftist government led Israel. A major factor in Likud's success was the frustration of Mizrahi Jews over discrimination. Begin's government notably included Ultra-Orthodox Jews and worked to bridge the Mizrahi–Ashkenazi divide and the Zionist–Ultra-Orthodox rift. Despite leading to hyper-inflation, Begin's economic liberalization allowed Israel to start receiving substantial U.S. financial aid. His government also actively supported Jewish settlements in the West Bank, intensifying conflict with Palestinians in the occupied territories.

In a historic move, Egyptian President Anwar Sadat visited Jerusalem in November 1977, invited by Israeli Prime Minister Menachem Begin. Sadat's visit, which included addressing the Knesset, marked a significant turning point towards peace. His recognition of Israel's right to exist laid the groundwork for direct negotiations. Following this visit, 350 Yom Kippur War veterans formed the Peace Now movement, advocating for peace with Arab nations.

In September 1978, U.S. President Jimmy Carter facilitated a meeting at Camp David between Sadat and Begin. The Camp David Accords, agreed upon on 11 September, outlined a framework for peace between Egypt and Israel and broader principles for Middle Eastern peace. It included plans for Palestinian autonomy in the West Bank and Gaza and led to the Egypt-Israel Peace Treaty signed on 26 March 1979. This treaty resulted in Israel returning the Sinai Peninsula to Egypt in April 1982. The Arab League responded by suspending Egypt and relocating its headquarters from Cairo to Tunis. Sadat was assassinated in 1981 by opponents of the peace agreement. Following the treaty, both Israel and Egypt became major recipients of U.S. military and financial aid.^[211] In 1979, over 40,000 Iranian Jews migrated to Israel, fleeing the Islamic Revolution.