After Frenkel drops out, Flug now front runner for Israel central bank chief
* Flug had been Fischer's choice
* Decision on new candidate due within days
* Market reaction to Frenkel withdrawal muted
JERUSALEM, July 30 (Reuters) - Deputy governor Karnit Flug is the front runner to become Israel's next central bank chief after Jacob Frenkel withdrew his candidacy on Monday following allegations of a suspected shoplifting incident in 2006.
Filling the shoes of long-time governor Stanley Fischer, who stepped down last month after eight years at the helm and was well regarded internationally, will be a tough task.
Flug had been Fischer's preferred choice to succeed him but was overlooked by Prime Minister Benjamin Netanyahu who wanted someone with more international experience.
He nominated Frenkel, a governor of the bank in the 1990s who has also held executive positions at AIG and JP Morgan Chase International, last month but Frenkel suddenly pulled out of the running on Monday following allegations in the media of a shoplifting incident at Hong Kong airport in 2006. Frenkel has called the incident a "misunderstanding".
Bank Hapoalim Chief Economist Leo Leiderman had also been suggested in the media as a possible candidate for governor.
Analysts, commentators and lawmakers called on Tuesday on Netanyahu and Finance Minister Yair Lapid to appoint Flug, despite her lack of international credentials.
Flug chaired the bank's first policy meeting since Fischer's departure on Monday.
"I call on the prime minister to appoint Karnit Flug as Bank of Israel governor," Gila Gamliel, a member of Netanyahu's Likud party and deputy chair of parliament, wrote on her Facebook page. "Karnit is a professional and respected in her field, and this is also an opportunity to appoint a woman for the first time."
Netanyahu and Lapid in a joint statement said a decision on a new candidate would be made in the coming days, which analysts believe bodes well for Flug. A spokesman for Netanyahu declined to elaborate.
"The uncertainty around this issue is not something the markets will bear for a long time," said Ori Greenfeld, head of macro and strategy at the Psagot brokerage, who backs Flug for the post. "The markets need certainty."
Fischer, a former deputy managing director of the International Monetary Fund and vice chairman of Citigroup , announced his resignation in January but Frenkel was only nominated a week before he was set to leave.
MARKET REACTION MUTED
Israeli media reported in July that Frenkel was detained at Hong Kong airport in 2006 on suspicion of stealing cologne from a duty-free shop. He was later released without charge.
The Turkel committee, which vets all appointments of Israel's senior civil servants, had been looking into the matter and asked Attorney General Yehuda Weinstein to examine the incident.
Frenkel said he has been the subject of a smear campaign.
Central bank policy is not expected to be affected by the uncertainty about the leadership and the Monetary Policy Committee held interest rates steady for a second straight month on Monday.
Fischer had lobbied for Flug as his replacement, saying she would make a good central bank chief.
"Fischer knows her better than anyone and if he thinks she is good for the economy, I am with him," said Modi Shafrir, chief economist at ILS Brokers.
Flug worked as an economist at the International Monetary Fund in Washington in the mid-1980s, but has spent the last 25 years at the Bank of Israel, as head of research between 2001 and 2011 and then as Fischer's deputy.
"Flug is the ideal governor for the Bank of Israel in 2013," Sever Plocker, an economic commentator, wrote in the mass daily Yedioth Ahronoth.
Greenfeld noted that market reaction to Frenkel's withdrawal has been muted, with the shekel and bond prices holding steady, because "markets understand that whoever will be governor, there is a monetary policy committee and the direction of monetary policy won't be changed."
(Editing by Susan Fenton)