The central bank also raised its GDP growth forecast for 2012 from 3.1% to 3.3%. In 2013, the economy is expected to experience a slowdown and grow by just 3%.
"We assess that the taxation steps taken by the government (raising VAT, import taxes and income tax), the continued increase in the housing component, an increase in energy and commodities prices, the significant depreciation of the shekel that took place in the third quarter of the year, and the expected increase in real salaries in the public sector in 2013, will be the main factors in the rise in inflation during the next year," the bank said in its review.
"In contrast, the continued slowdown in global economic activity will have a restraining effect on inflation due to reduced demand."
The government has set an annual inflation target range of 1-3%, and it is the Bank of Israel's responsibility to ensure that the economy meets this target. Senior bank officials tend to support a restraining policy – in other words, raising interest rates or avoiding cutting interest rates even at times of economic slowdown.
On Monday, the bank's Monetary Committee decided to leave its key interest rate for the month of October at 2.25%, for the fourth time in a row.
'Positive surprise' in GDP growth data
The bank's Research Department also updated its GDP growth forecast for 2012, which stood at 3.1% at the end of the previous quarter and has now been raised to 3.3%.
"The forecast for 2012 was revised slightly upward by 0.2 percentage points compared to that published in June. The revision is mainly the result of a positive surprise in GDP growth data during the first half of the year, mainly influenced by exports, which was partially offset by a more pessimistic outlook for the second half of the year."
It should be noted that according to the Central Bureau of Statistics, the Israeli economy grew 3% in the first half of 2012 and is expected to grow at an annual rate of 3.5%.
The 2013 forecast, however, has been updated downwards – from 3.5% to 3%, "against a backdrop of a continued global slowdown and the tax steps
taken by the government, which are intended to contribute to the stability of the economy.
"The downward revision of the forecast is reflected in all components of demand other than public consumption, with the most prominent revision being in investments and exports."
The review also notes that "the moderation in domestic demand is also projected to be reflected in a marked slowdown in import growth, which is expected to grow by just 2% in 2013."
The decision to lower the bank's growth forecast to 3% is particularly important in light of Bank of Israel Stanley Fischer's objection to Finance Minister Yuval Steinitz's decision to raise the fiscal deficit target for 2013 to 3% three months ago.
The new growth forecast signals that the central bank believes the government will be unsuccessful in reducing its debt-to-GDP ratio next year, a reality which may lead to a downgrade in Israel's credit rating.