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Bank of Israel holds key rate, raises growth forecasts

By Steven Scheer and Ari Rabinovitch

By Steven Scheer and Ari Rabinovitch

JERUSALEM (Reuters) - The Bank of Israel kept its benchmark interest rate <ILINR=ECI> at 0.1 percent for a 19th straight month on Monday and raised its growth forecasts after recent data suggested the economy may be expanding faster than previously thought.

All 12 economists polled by Reuters had forecast no change by the central bank, with most also projecting no rate move until at least late 2017.

"We have received a batch of data over the past three months that indicates -- for now -- a marked improvement in the real economy," Bank of Israel Governor Karnit Flug said during a quarterly briefing with reporters.

She said the central bank had raised its 2016 growth estimate to 2.8 percent from 2.4 percent and the 2017 forecast to 3.1 percent from 2.9 percent.

Israel's economy expanded by an annualized 4.0 percent in the second quarter of 2016, according to the government's second estimate that was revised up from a preliminary 3.7 percent. Growth was led by consumer spending but exports rebounded after recent weakness.

"It is very important that the recovery in exports continues, and that it is accompanied by continued growth in investment in the principal industries," Flug said.

The annual inflation rate fell to -0.7 percent in August from a five-month high of -0.6 percent in July, still well below the government's annual target range of 1-3 percent. Israel has now been in a deflation trend for 24 months.

Flug said that a strong labor market and rising wages had not yet led to an increase in the inflation rate because lower commodity prices have allowed manufacturers to absorb salary increases without having to raise product prices.

But if commodity prices, especially fuels, keep stable, and global deflationary trends continue to moderate, then she said wage gains and growth in private consumption will support the convergence of the inflation rate to within the target.

Nevertheless, "it is likely that this convergence will take longer than we expected in the past", Flug said.

The central bank's economists expect inflation to return to within its target range in late 2017, and they forecast that the inflation rate for the four quarters ending in the third quarter of 2017 will be 1 percent.

Interest rates are forecast to remain steady until the third quarter of 2017, they said, with a 0.15 percentage point increase to 0.25 percent in the fourth quarter.

Flug noted that while monetary policy will remain accommodative for a considerable time, the central bank will continue to buy foreign currency in a bid to contain shekel appreciation.

In the past month, the shekel <ILS=> has strengthened by 0.2 percent against the dollar, and by 0.3 percent in terms of the nominal effective exchange rate. Over the prior 12 months, the shekel appreciated by 4.9 percent in terms of the nominal effective exchange rate, the bank noted.

(Additional reporting by Tova Cohen; Editing by Catherine Evans)