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© Reuters. FILE PHOTO: The Bank of Israel building is seen in Jerusalem June 16, 2020. Picture taken June 16, 2020. REUTERS/Ronen Zvulun/File Photo By Steven Scheer

JERUSALEM (Reuters) – Israel’s central bank should be prepared to raise interest rates and taper foreign exchange intervention if inflation pressures intensify further, the International Monetary Fund said on Sunday.

In a statement following its annual visit, the IMF said there was room for Israel’s government to raise taxes while also advising more efficiency in state spending.

Israel’s inflation rate was 2.8% in 2021, within an official 1-3% target and well below rates seen in many Western peers, but the IMF said rising services prices, a high rate of capacity utilization, and wage gains in some sectors “show incipient signs of underlying inflationary pressures”.

“If underlying upward pressures become more salient, the Bank of Israel should be ready to tighten monetary policy,” the IMF said.

Iva Krasteva Petrova, IMF mission chief for Israel, told reporters that since inflation is within target there is no need for monetary tightening now but that the central bank should remain vigilant. She also expressed concern over high housing prices.

At the same time, the IMF said “foreign exchange purchases should taper off, allowing the shekel to be determined by market forces, without precluding future purchases should (shekel) appreciation pressures threaten to move inflation or inflation expectations below the target band”.

The central bank has said it is not worried about an inflation outbreak, and that allows it patience in conducting monetary policy.

The IMF praised the government’s management of the COVID-19 pandemic and its aim of lowering Israel’s debt burden over the medium term.

But it warned the planned consolidation relies on spending reductions that may prove challenging given already low civil spending. “Conducting a review of public spending efficiency would be useful,” it said

The government has scope to increase tax revenues, the IMF said, adding: “The tax system could be made more progressive and the tax base could be broadened, including by reducing pension tax exemptions and personal and corporate tax incentives for selected groups.”

After 6.5% growth in 2021, the IMF expects solid economic growth in Israel in 2022, supported by consumer spending, investment and exports.

It said that new COVID variants could be a threat to economic growth, while tightening of global financial conditions could jolt stock markets, lower government revenue and raise the cost of capital.