By Steven Scheer
JERUSALEM, June 2 (Reuters) - Israel's short-term interest rates could fall at a faster pace if inflation continues to ease as a result of increased optimism over a ceasefire deal with Iran that has pushed down energy prices, Bank of Israel Governor Amir Yaron said on Tuesday.
Yaron, speaking at an Israel Democracy Institute conference, noted that since the last interest rates decision on May 25, oil prices on ceasefire hopes had dropped, and along with a stronger shekel versus the dollar
, inflation expectations have declined.
Prior to the decision, the bond market had expected an inflation rate of 1.7% in the coming year, well within the government's annual 1-3% target range. The rate was 1.9% in April.
"As inflation expectations decline — and certainly if they approach the lower bound of the target range — this justifies a more accommodative monetary policy and a faster pace of easing," Yaron said.
LOWER RATES
Policymakers last week reduced the benchmark interest rate to 3.75% from 4% - its first cut since January and third since cuts resumed in November - but said future cuts would be gradual due to the uncertainty over the Iran war.
Yaron said the decision reflected, among other things, a balancing of opposing geopolitical risks: war versus an agreement, rising energy prices versus falling prices, currency appreciation versus depreciation.
He noted that Israel's risk premium had continued to decline over the past week on hopes of a deal with Iran.
"All of these developments have further lowered inflation expectations," Yaron said.
U.S. President Donald Trump said on Monday that negotiations with Iran were continuing and there would be a deal over the next week to extend a ceasefire agreed in early April and reopen the Strait of Hormuz.
Earlier at the conference, a host of business leaders had criticised the central bank's cautious monetary policy, saying that high rates had led to a 33-year high in the shekel versus the dollar and were harming the economy.
After Yaron's comments, the shekel retreated by 1% to 2.845 after hitting a new post-1993 high of 2.80 on Monday.
Yaron defended the monetary committee's policy, saying it had led to a decline in inflation.
He said that Israel's economy had recovered well from the Gaza and Iran wars, showing resilience compared with previous military conflicts. The main drag on growth, he added, had come largely from supply constraints, mainly in the labour market, with many civilians called up for military reserve duty.
(Reporting by Steven Scheer; Editing by Andrew Heavens and Gareth Jones)
