A rate gap that is too large would tend to harm Israel's economy, adding upward pressure on an already strong shekel currency and weakening exports, Stanley Fischer said.
"We are a very open economy - open to exports and even more to flows of capital. And our interest rates are heavily affected by the rest of the world," he told a conference in Herzliya.
"If our rates are high relative to the United States and Europe, money comes here to take advantage of the high rates and that creates an appreciation of the shekel and that has negative effects (on the economy). We can't let the interest rate gap get too large."
The Bank of Israel has left its benchmark lending rate at 1.75% in the last two months, well above the zero to 0.25% base rate in the United States and the European Central Bank's 0.75%.
Both foreign central banks are using ultra-loose policies to stimulate weak economies.
The US Federal Reserve is focused on a bond-buying program that it is not expected to change when its policy-setting panel meets next week, while a minority of economists believe the ECB could cut rates in coming months.
'Very strong economy'
Minutes of the Bank of Israel's February meeting suggested on Monday that further interest rate cuts look unlikely for the time being given signs the economy is improving and residual concerns about a lively housing market.
Israel's shekel is at 3.685 per dollar, close to a 16-month peak.
The country's economy, 40% dependent on foreign trade, expanded 3.1% in 2012 but growth is projected to slow to a rate of 2.8% in 2013 excluding the start to natural gas production.
"This is a very strong economy," Fischer said, pointing to the ability to have withstood many shocks – including three military campaigns the past eight years – while weathering the global economic crisis better than most.
Fischer, who is stepping down at the end of June, attributed much of the economy's success to a stable and conservative banking system.
But one glaring problem in the short run is fiscal policy, and Fischer said that even if the government makes the necessary budget cuts, raises taxes and meets a budget deficit target of 3% of gross domestic product in 2013, the budget will be expansionary.
To meet the deficit target, about NIS 14 billion ($3.8 billion) of spending will need to be reduced while tax revenue of an extra NIS 6 billion ($1.63 billion) is required, analysts said.