Israel economy strong, risks overheating on rate hike delay -OECD

JERUSALEM, March 11 (Reuters) - Israel's economy faces a risk of overheating should the Bank of Israel wait too long to start raising interest rates, the Organisation for Economic Co-operation and Development (OECD) warned.

In a report issued on Sunday, the OECD said Israel's economy continued to register "remarkable macroeconomic and fiscal performance" and that it expected a major payoff to come from planned investments in offshore natural gas fields.

It also said that while income inequality had fallen, the share of working poor had grown due to low paid jobs in Israel's two weakest labor sectors - Arabs and Ultra-Orthodox Jews.

The OECD praised the central bank for maintaining a very accommodative policy, in which the benchmark interest rate has stayed at 0.1 percent for three years, while buying foreign currency from time to time to prevent an excessive appreciation of the shekel. But it also issued a warning.

"The risks of maintaining an accommodative monetary policy too long should not be neglected, as the favorable effects from the terms-of-trade gains could reverse quite rapidly," it said.

"Low inflation does not seem related to weak demand, and tightening too late would increase the risks of overheating and rising wage pressures, which, with increased competition, would harm business profitability and investment."

Israel's annual inflation rate was at 0.1 percent in January but the Bank of Israel expects the rate to move back into the government's 1-3 percent target by year-end, boosted by rising wages. Similarly, the OECD projects a 1 percent rate in 2018, rising to 1.7 percent in 2019.

As such, Bank of Israel economists expect a 15 basis point rate increase to 0.25 percent by the end of 2018, although most private economists believe inflation will move back to its target only in 2019, with the first rate hike also next year.

Policymakers have stressed that rate hikes would start only when inflation is entrenched in the target range.

Israel's economy grew 3.3 percent in 2017, helped by strong population growth and a robust high-tech sector, and the OECD forecasts 3.5 percent growth this year and 3.4 percent in 2019, in line with central bank estimates.

It noted that production of the Leviathan gas field late in 2019 will add 0.3 percentage points to economic output while a sovereign wealth fund being set up from excess profits from gas sales could represent 10 percent of gross domestic product by 2040, the OECD said.

The OECD largely praised the state's fiscal policy and a declining public debt burden but recommended more spending on education and transportation infrastructure as well as improving tax collection. It said Israel should loosen a "rigid" policy on real estate supply to lower home costs since "risks of a house-price correction are still high." (Reporting by Steven Scheer Editing by Mark Potter)