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As "amends for their sin" of overestimating growth in 2001 and 2002, the Bank of Israel and treasury have underestimated Israel's economic growth for 2003, claims Nessuah Zannex chief economist Shlomo Maoz. "They may now get carried away in the other direction, and push the economy into deep recession through contractionary monetary and fiscal policy," Maoz warned.

Maoz has lowered his inflation expectations for 2002 to 5%, from his previous estimate of 5.7%.

His inflation expectation for the coming 12 months is 1.1%, compared with his previous forecast of 1.8%.

Maoz predicts that the Bank of Israel's recent rate hikes will be the last in this round. From this point policy will be reversed and the central bank will gradually start lowering interest rates, he says.

He predicts that the central bank will lower the rates by 0.5% by October, then by another 0.5% by year-end. In 12 months Maoz sees central bank interest dropping to 6.9%, which would be 2.2% below the current rate.

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Looking at the dollar, Maoz sees it hovering around NIS 4.75 this week, with 3-agorot deviation in either direction. The 7.35% interest rate gap with the dollar should stop the shekel's devaluation for now, he says, as Israeli institutional investors mainly provident funds and insurance companies - return to shekel vehicles of investment.

Additional support for the shekel comes from treasury efforts in recent days to convey that mistakes of the past, including losing the reins controlling the budget, won't be repeated in 2003.

In the bonds market, Maoz says that capital gains can still be expected on Shahar bonds because of the decline in inflation, and the anticipated reversal of the yields chart on shekel vehicles.

But he warns that the rate rise last week will continue to hurt medium-term bonds linked to the CPI. By August yields in these ranges could climb to 6.25% or 6.5%. Medium- and long-term bonds are still attractive, according to Nessuah Zannex, and could rise.

Nessuah Zannex believes that the yields chart on linked bonds has already turned around, although it's early to say whether the reversal is genuine or merely a fluctuation after the confusion of last week.