The Bank of Israel, which cut rates by 100 basis points in 2012, said the global macroeconomic picture was mixed, and while there are signs of a recovery in the U.S., the slowdown continues in Europe.
However, it "appears that there has been a decline in the probability of a crises occurring, a development which has reduced the high level of uncertainty that prevailed in the last year," the BOI said, a reference to the lack of volatility in financial markets - so far - to last week's events in Cyprus.
Although the BOI is largely neutral in its policy guidance, it said that it was keeping a "close watch on developments in the asset markets, including the housing market" and cautioned that a larger government deficit would lead to higher interest rates.
"The path of the interest rate in the future depend on developments in the inflation environment, growth in Israel and in the global economy, the monetary policies of major central banks, and developments in the exchange rate of the shekel," the BOI said in a statement.
The BOI said that one of the sources of economic uncertainty was the government's fiscal policy, which the deficit having to be reduced according to the expenditure rule. Even after such a deficit reduction, the BOI said the budget would reflect a real 4.5 percent rise.
"Deviation in the government deficit is liable to lead to increased interest rates in the economy," the BOI said.
Israel's inflation rate was steady at 1.5 percent in January and the BOI said forecasters' projections for inflation over the next year on average were 1.8 percent.
Israel's Gross Domestic Product rose by 0.6 percent in the fourth quarter from the third quarter for annual expansion of 2.7 percent, down from 2.9 percent in the third quarter.
"Updated indicators of economic activity in February point toward continuation of the signs of improvement which began to be seen in January, but it is still too early to determine if this is a positive turning point," the BOI said.
Growth this year is forecast by the BOI's staff at 3.8 percent and 4.0 percent in 2014, including the impact of natural gas production. This 2013 forecast is similar to the bank's forecast from December.
Excluding the effects of natural gas production from "Tamar" drilling, GDP growth is expected to be 2.8 percent in 2013 and 3.3 percent in 2014, the BOI said.
The BOI's highly-respected governor, Stanley Fischer, is stepping down on June 30 after more than eight years in his post.