Unless the dollar drops from NIS 4.85, we should expect a sharp interest rate hike within several days and Bank of Israel intervention in the foreign currency market through shekel acquisition, investment bank Nessuah Zannex Chief Economist Shlomo Maoz said.

Maoz said that the 13.5% devaluation in the shekel since December's sharp interest rate cut threatens the objectives of the government and the central bank to sustain long-term price stability. He said that the weakening of the shekel increases the likelihood of the economy slipping into stagflation - recession accompanied by inflation.

The economist believes that the present low value of the shekel exceeds the balance of the local economy making renewed offerings of New Gilboa dollar-linked bonds, in an effort to calm the foreign currency market, likely.

Maoz bases this on the view that the damages involved in the weakening of the shekel exceed any embarrassment involved in retracting the decision not to issue dollar-linked bonds.

Maoz expects that the government deficit in 2002 will come to 5% of gross domestic product. He expects the budget cut and tax plan to be complete next year and that GNP will rise by 3% in 2003, due to global recovery and economic growth. This could increase state revenue by NIS 11 billion to NIS 14 billion, allowing a government deficit in the range of 2% to 2.5%.

Maoz states that Israel's economic recovery based on U.S. and Southeast Asian economic recovery and slight Euroepan recovery in the second half of the year will increase government revenue from tax on consumption by the end of this year and increase projected revenue for 2003.

Accordingly, Maoz expects that in the third and fourth quarters this year indexed bond yields will start dropping, as compared with other bonds the indexed bonds are in good shape because they are already taxed at 35%.

Taxing non-indexed treasury bonds by 15% to 25% will prevent yields dropping in coming weeks, Maoz said. But he expects that over several months, once calm is restored, and low indices appear, it's certainly possible that long-term yields will drop to a range of 7.2% to 7.5%, and that medium-term yields will drop to a range of 6.5% to 6.8%.

The tax will fall on both savers and borrowers, which means that increased yields in recent days comes to overshooting, Maoz said.

Maoz said that the planned capital gains tax will be imposed only on real earnings, which is why he views the panic in the capital markets as exaggerated. He believes that once the emergency economic plan is released, the panic will subside in a matter of weeks.