Bank of Israel Deputy Governor Andrew Abir poses for a picture in his office in Jerusalem July 8, 2020. REUTERS/Ammar Awad

By Steven Scheer

JERUSALEM (Reuters) -Israel's central bank should not rush to cut interest rates in response to the Gaza ceasefire and last month's inflation dip as the economy is doing well and improving consumer demand could stoke price rises, its deputy governor said on Thursday.

Israeli policymakers have come under pressure from politicians, industrialists and mortgage holders to finally loosen the reins after more than three years of high interest rates, which remained at 4.5% during most of the two years of war between Israel and Palestinian militant group Hamas.

Officials hesitated to lower rates during the war but the U.S.-brokered deal has halted the fighting. In the face of receding inflation, markets have begun anticipating near-term rate cuts at the central bank's Nov. 24 meeting, or even before.

But Andrew Abir told Reuters that while some indicators supported the case for rate cuts, such as easing inflation and a lower risk premium, the Bank of Israel would remain cautious.

Inflation declined in September to 2.5%, within the 1-3% target and the downward trend could be abetted by an end to labour supply constraints, which had stoked prices, as military reservists return home to day jobs following the ceasefire.

Abir cautioned, however, that a likely rise in consumer demand with the war over could stimulate inflation again.

"You could expect sort of a demand-side bonanza given the change in sentiment and the two forces (supply and demand) are obviously acting in different ways on inflation. It's very difficult ... to know which will have a stronger effect."

While also worried about overheating the housing market, Abir said, the central bank was sticking to policy that so far has succeeded in bringing inflation back to the target and maintaining market stability.

"We don't want to ruin that, so we are still going to be cautious going forward about adjusting our monetary policy for the new environment," he said.

"We live in the Middle East and things can change quickly so we are not going to rush ahead with (lowering rates) just because there has been a cessation of hostilities for the last week or so."

NOT BEHIND THE CURVE

Abir said an inflation rate of 2.5% was still near the upper end of the range while the economy has performed better than he had believed it would throughout the war.

Where consumer demand will be in the next six to 12 months will drive the monetary policy debate, he said, both in terms of the "direction of interest rates and the pace of the change", especially with the economy near full employment.

"These are not things that signal we are behind the curve. We need to make on estimate (on demand) to be able to set what tightness of monetary policy is needed to make sure inflation stays with the range."

Abir said that with the Gaza war having seemingly stopped earlier than expected, the bank's 2.5% growth estimate for 2025 could be revised higher. "We are not in a terrible situation where we have to rush into cutting rates big time. The economy is doing well," he said, also pointing to solid investment.

Abir said the end to fighting should also benefit fiscal policy due to lower defence spending, a situation the government should use to cut debt levels.

He said that despite the shekel, intervention is not needed since markets are functioning well.

(Reporting by Steven ScheerEditing by Tomasz Janowski)