In the second quarter, the economy grew an annualized 1.7 percent according to the government's preliminary estimate, well below expectations of a 2.5 percent rise and slower than a 2.8 percent pace in the first three months of the year.
"There was a further slowdown in economic growth, particularly in goods exports, even before the deterioration in the security situation," the Bank of Israel said in a statement accompanying the rates decision.
It added that labor market data indicate a halt to the improvement in employment and it foresaw in particular an extended negative impact in tourism and in private consumption.
The previous rate of 0.5 percent had matched that seen during the height of the global financial crisis in 2009 but the benchmark rate had never been lower until today. The rate has gradually fallen from a high of 3.25 percent in mid-2011.
Two moves in as many months is rare in Israel—last seen in May of 2013 when the central bank cut rates twice. But the reduction came amid a seven-year low in the inflation rate and data showing Israel's economy was weakening.
Israel's annual inflation rate eased to 0.3 percent in July—below the government's target range of 1-3 percent. Some policymakers have blamed weak consumer demand for the benign inflation.
"There was an additional decline in the inflation environment this month," the central bank said. It added that expectations in the coming year are close to 1 percent.
Israel's shekel weakened by 1.7 percent this month versus a basket of currencies and "continued depreciation will support a recovery in exports and in the tradable sector," the Bank of Israel said.
Jonathan Katz, economist at Leader Capital Markets, said he thought the central bank would wait a few months before lowering rates again.
"The combination of the decline in inflation, a decline in inflation expectations, a moderation of economic activity in the second quarter even before the Gaza operation and a global picture that is not really encouraging—especially in Europe and Japan—supported the decision to lower interest rates,'' he said.
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After the rates announcement, the shekel weakened to 3.57 per dollar from 3.5430 while key Tel Aviv stock indexes rose 0.8 percent.
Flug said the main short-term influence is expected to be in the foreign exchange market, in which the shekel has weakened more than three percent against the dollar the past month to a six-month low—after reaching a three-year high last month and prompting calls from exporters for aggressive action.
"I think that this lowering of the interest rates will contribute to the depreciation, and this will strengthen the ability of exporters to compete in the world, remembering that the world is still in very moderate growth and our main markets are suffering so the ability to strengthen the competitiveness of exports is very important especially at a time like this," she said.
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Harel's Klein does not believe the low rate environment will remain for long. "When interest rates start to rise around the world around the middle of 2015, Israel's rates will also rise," he said.