The Bank of Israel is leaving key lending rates for August unchanged from July, governor David Klein announced on Monday.

The central bank is leaving the rate on its sources at 9.1%, Klein announced at 16:30 Israel time. Despite the drop in bond yields, there are still threats to price stability, he said. Inflation expectations have been dropping again to the upper edge of the government target for 2002 after the steep rate hikes in June, but events abroad and security problems at home could create pressure on the shekel again.

Inflation expectations have dropped to around 3%. Experts believe that consumer prices will stay stable or drop in the months to come, which makes the current real high interest rate a dead weight on the business sector.

Even though a rate cut could have helped business, experts had expected no change in the rates, for several reasons. Consumer prices rose by much more than expected in June, 1.3%, compared with expectations of about half that rate.

For another thing, Israel's leaders have been waffling on budget cuts for 2003. While the treasury seems serious about reducing government spending, including on the sensitive issue of defense, the Knesset last week voted against the budget the treasury proposed.

Nonetheless, Prime Minister Ariel Sharon and Finance Minister Silvan Shalom have estimated that the budget cuts can be pushed through parliament in another round of voting Tuesday.

In any case, expects said, the central bank was unlikely to accept the government's promises to restrain spending, after previous promises granted in December 2001 when the central bank lowered the rates by a steep 2% to 3.8% - were not honored.

The sharp rate cut and other influences set off an inflationary spiral, curbed by a serious of steep rate hikes in June that lifted the central bank rate 4% in a month to a nominal rate of 9.1%.

Last week the Bank of Israel took steps to increase the shekel-dollar interest gap, by allowing Israel's banks to reduce their foreign-currency deposits held at the central bank, thus freeing resources for lending. The central bank agreed that the banks reduce their liquidity by 1% a month, which adds some $400 million a month to the banks' resources.

The shekel edged up today on assessments that the lending rate would stay firm. The shekel's representative, or official, rate was set at 4.7310 shekels from 4.7410 shekels on Friday. Activity was light ahead of the rate decision, Israel Discount Bank dealer Mike Rabinowitz told

Reuters

. The shekel had hit a four-month high last Monday but stalled after the Israeli strike on Gaza that killed its target, a Hamas commander, but also killed 14 civilians, sparking fears of retaliatory violence.