The pace of Israel's economic deterioration is slowing, announced Bank of Israel governor David Klein today.

"The economic data do not yet indicate stabilization of economic activity, but it seems that the pace of economic deterioration is slowing," write the Bank of Israel in their semi-annual report, published today.

"Economic indicators for the first half of 2002 show that the recession in economic activity continued. Unemployment edged up to 10.6%, industrial performance did not significantly change, and industrial production and import of production materials grew slightly," the report states.

Israel's gross domestic product grew moderately during the first six months of 2002, mainly due to increasing government spending. Second-quarter figures show however that exports dropped and imports froze, which does not portend well for second-half growth.

Wages dropped in real terms, the Bank of Israel continues, which could reduce demand and further slow economic activity. Conversely, the drop could also reduce the cost of labor to business, thus reducing the harm to the companies.

The Bank of Israel estimates that recent developments in world capital markets may slow down the pace of recovery but recovery is continuing. However, the rally is mainly in traditional sectors to which Israeli exports are low.

"The stabilization of the financial markets, appreciation of the exchange rate and drop in inflation expectations at the end of June were achieved through significantly raising interest rates and taking steps to restore budgetary discipline," the bank notes. "Another fiscal adjustment is key to preventing the devaluation from resuming and inflation expectations from rising."

Fiscal restraint by the government will facilitate future rate cuts, the bank says, adding that maintaining high interest rates currently 9.1% on central bank sources will ultimately harm the business sector.