The Bank of Israel (BOI), which has cut by 100 basis points this year, also cut its growth forecast for 2013 to 2.8 percent from a previous 3 percent, excluding the projected impact of the start of natural gas production from a new field in the second quarter.
Including the output from that field, the 2013 growth forecast is for 3.8 percent, up from forecast 2012 growth of 3.3 percent, but down from 2011's 4.6 percent.
Israel's Gross Domestic Product in the fourth quarter is expected to decline from the third quarter due a slowdown in exports related to global economic weakness, the bank said.
Israel's economy grew by 0.7 percent in the third quarter for annual growth of 3.12 percent, slightly down from 3.24 percent in the second quarter.
"In addition, the shekel's recent strength may make it more difficult for the economy to deal with the challenges it faces," the BOI said, adding the level of global economic risks remain high and there is still uncertainty regarding the U.S. fiscal situation and Europe's debt crises.
Israel's inflation rate fell by a monthly 0.5 percent in November to an annual rate of 1.4 percent, down from 1.8 percent, the third consecutive month in which inflation has surprised on the downside.
The BOI said forecasts for inflation over the next 12 months have also declined to around 1.8 percent and average expectations for the central bank's interest rate one year from now are for 1.8 percent.
The BOI's own staff now expects 2013 inflation of 1.8 percent, down from its previous forecast of 2.2 percent. The bank targets inflation of 1-3 percent.
Through Dec. 21 from Nov. 25, the shekel has strengthened some 3 percent agains the U.S. dollar and 1.5 percent against the euro due to renewed purchases by nonresidents, the bank said.
Home prices rose by 0.5 percent in September-October for an annual rise of 3.7 percent, up from 2.3 percent, but the bank said it was too early to "assess the impact on home prices on the LTV ratio limitations which were imposed by the Supervisor of Banks and went into effect at the beginning of November."
"Against the background of the need to provide additional support for economic activity and the absence of inflationary pressures at this time, the Monetary Committee decided to reduce the interest rate by 0.25 percentage points," the bank said.