November 25, 2019 / 2:51 PM / 19 days ago

UPDATE 2-Bank of Israel holds key rate, cautions on political uncertainty

* Most analysts had expected first rate cut since 2015

* Central bank says taking steps to make policy more accommodative

* Shekel up 7.5% vs dollar, up 9% vs currency basket so far in ‘19

* Inflation rate stands at 0.4% (Adds shekel reaction, analyst comment)

By Steven Scheer and Ari Rabinovitch

JERUSALEM, Nov 25 (Reuters) - The Bank of Israel left its benchmark interest rate at 0.25% on Monday for the eighth decision in a row, confounding expectations among analysts and investors that it would cut borrowing costs for the first time in nearly five years.

The bank said economic growth was solid but warned that political uncertainty may ultimately harm the economy.

Ten of 16 economists polled by Reuters had predicted the central bank would lower the key rate to 0.1% as the strong shekel is helping to keep inflation close to zero. Six others forecast no change.

“It will be necessary to leave the interest rate at its current level for a prolonged period or to reduce it in order to support a process at the end of which inflation will stabilize around the midpoint of the target range, and so that the economy will continue to grow strongly,” the central bank said in a statement. It said its analysis was based on a host of local and global factors.

“The (monetary policy) committee is taking additional steps as necessary to make monetary policy more accommodative,” it added — a likely reference to intervention in the foreign exchange market to stem shekel strength.

The Israeli currency has gained 7.5% so far in 2019 against the dollar and some 9% versus a basket of currencies of main trading partners.

Annual inflation edged up to a rate of 0.4% in October — well below the government’s 1-3% target — from 0.3% in September but it was down from a peak of 1.5% in May.

“The (shekel’s) appreciation continues to make it difficult to return inflation to the target range,” the central bank said.

The central bank bought $314 million of foreign currency in October, its first major intervention in 2019.

POLITICAL UNCERTAINTY

Israel’s economy continues to grow at around 3% percent, which is considered the country’s potential, while the labour market remains tight, the bank said.

“However, the political situation remains uncertain, and if the government is forced to operate on a continuance budget for a prolonged period, it may have a contractionary effect.”

The Israeli economy has so far weathered two inconclusive elections and a year of successive caretaker governments. But the political stalemate means it will be well into 2020 before a new annual budget is passed, triggering months of cutbacks that are likely to drag on economic growth.

Prime Minister Benjamin Netanyahu was indicted last week on corruption charges, plunging Israel into further political disarray after neither he nor his main challenger, centrist Benny Gantz, secured a parliamentary majority in April and September elections.

Until a new budget is passed, government ministries will be funded according to their 2019 monthly allocations, making it harder to commission new roads, pay contractors and cover a growing deficit.

The shekel was flat against the dollar after the decision after gaining as much as 0.5% earlier.

Analysts still believe the chance of a rate cut in 2020 remains high. The next decision will be on Jan. 9.

“The likelihood of interest rate reductions in the coming months as well as foreign exchange purchases is still significant, especially in the event that we return and see a rapid appreciation of the shekel,” said Ofer Klein, head of economics and research at Harel Insurance and Finance. (Additional reporting by Tova Cohen; Editing by Catherine Evans)

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