July 9, 2018 / 2:29 PM / 8 days ago

UPDATE 2-Bank of Israel holds rates, on track for Q4 hike on rising inflation

(Adds details, governor and analyst comments)

By Steven Scheer and Ari Rabinovitch

JERUSALEM, July 9 (Reuters) - The Bank of Israel on Monday left its benchmark interest rate unchanged at 0.1 percent and continued to hold out the prospect for a small increase by the year-end due to rising inflation and strong economic growth.

The decision to hold rates for the 35th straight decision since early 2015 came three days after Governor Karnit Flug said she would not seek a second-five year term when her tenure ends on November 12.

Flug reiterated that for interest rates to rise, inflation needed to be entrenched within the government’s annual target range of 1 to 3 percent, which she said does not mean inflation needs to get to 2 percent.

The inflation rate edged higher to 0.5 percent in May, although expectations are for inflation to reach the target in the next few months.

“The (monetary policy) committee will want to be certain, to the extent possible, that the return of inflation to the target range will not last for only a few months,” Flug told a news conference.

“We will therefore need to wait and see how the inflation environment develops before we will be able to establish that it is entrenched within the target.”

A hike too soon could delay inflation staying within the target and slow the path of rate hikes, she added.

The central bank’s own economists, in an updated forecast, project an inflation rate of 1.1 percent by the end of 2018 and 1.5 percent in 2019. Inflation has been rising on higher wages as Israel’s labour market is at full employment, as well as gains in global oil prices.

Israeli government bond yields have risen since the last decision in May. The bank’s economists continue to foresee a 15 basis point rate increase in the fourth quarter to 0.25 percent, and another quarter-point hike in 2019 to end the year at 0.5 percent.

“The Bank of Israel is signalling that interest rates will be raised this year,” said Ofer Klein, head of economics and research at Harel Insurance & Finance. He added, though, that there conditions are not ripe for a rapid rise next year.

All 13 economists polled by Reuters before the decision had forecast no change by the central bank.

Israel’s economy grew an annualised rate of 4.5 percent in the first quarter, according to a second estimate. The central bank expects growth of 3.7 percent in 2018, up from a previous estimate of 3.4 percent, and 3.5 percent next year.

Israel, Flug said, is not directly impacted by trade wars but that could change if a trade war expands.

Flug, 63, who has had a rocky relationship with Finance Minister Moshe Kahlon and was Prime Minister Benjamin Netanyahu’s third choice when Stanley Fischer stepped down in 2013, last week said she would not seek a second term.

“I’m 30 years at the bank ... For me this is a suitable time to leave,” the Polish-born Flug said. “I think I am finishing a tenure that in my view was successful. I have a lot of satisfaction about what I did.”

She will head at least the next two rate meetings in August and October. Kahlon and Netanyahu have yet to choose a successor. (Reporting by Steven Scheer and Ari Rabinovitch; editing by David Stamp)

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