While fast economic growth will boost the gross domestic product by another 5 percent by the end of 2006, led by growth in the business sector, a slower growth rate in the business sector next year is expected to hold back the economy somewhat, the Bank of Israel said Sunday. The increased prediction from the central bank replaces its most recent forecast for 4.2% GDP growth, bringing its closer in line with the Finance Ministry's outlook for 5.3% growth. If the Finance Ministry prediction is realized, 2006 growth will be at its fastest pace since the GDP advanced 7.7% in 2000. The economy grew 5.2% last year; 4.4% in 2004; and 1.7% in 2003. In 2007, the business product is expected to grow about 5.1%, down from a predicted 6.5% for 2006, as the economy approaches full realization of surplus production capacity, and bringing GDP growth back down to 4%, the central bank said. Unemployment is expected to keep dropping to about 8.5% by year's end and to 8.2% next year, while the near exhaustion of surplus production capacity will contribute to a relatively high increase in employees' wages, according to the central bank. Bank of Israel researchers based their forecasts on the assumption that the country's geopolitical condition will remain unchanged; that rapid growth in Israel will continue to be supported by the state of the world economy - particularly 7.9% expansion in international trade by the end of 2006 and 7.5% trade growth next year; that fiscal policy will meet a target of 1.7% real growth in spending yearly, alongside full execution of plans to lower taxes; that the implementation of coalition agreements will lead to increased transfer payments; and that real short-term interest rates will rise over the coming two years as a result of narrowing in Israel's output gap and developments abroad. The central bank also predicted that exports (excluding diamonds) are expected to grow at a slower pace than overall international trade this year. Consumer spending is expected to increase due to a 4.3% rise in disposable income in 2006, while an expected continuation in tax cuts and reduced deficit are expected to enable another drop in the level of private savings in 2007. Investments in the various sectors of Israel's economy are expected to grow significantly, and the residential construction sector is expected to recover. Surplus in the balance of payments in the current account is expected to grow in 2006, but contract in 2007 due to an expected rise in imports. The current account surplus in the balance of payments will rise in 2006 and decline in 2007, reflecting a considerable increase in investment in the economy. Domestic public spending is expected to rise 0.9% by the end of the year, while current spending grows 1.7%. "This growth rate is consistent with the expenditure target following the underutilization of public expenditure in 2005," the central bank noted, adding that domestic public spending will most likely not grow quantitatively. Increased transfer payments per capita and public sector wage raises - due to a rise in the minimum wage - will require cuts in other parts of the budget in order to meet the 1.7% yearly growth target for public spending, leading to quantitative stability in public spending. Separately, the central bank said foreign obligations in Israel totalled $165b. at the end of March, reflecting a $12b. rise during the first quarter, due mostly to Teva's $7.6b. purchase of American pharmaceutical company Ivax. "Without this deal, a slowdown would have been registered in the first quarter of 2006 in the financial investments of foreign residents in Israeli stocks, though in April and May a rise was again registered in these investments," the central bank said. Direct investments continued to grow, with foreign residents investing another $2b. in the first quarter, "the lion's share ... directed to small non-negotiable companies in hi-technology sectors," the Bank of Israel said. The public sector owed $31.7b. abroad at the end of March, with further borrowing cancelled due to higher-than-expected tax revenues and the government's policy of reducing debt. Assets abroad held by Israelis totalled $139b. at the end of March, $16.4b. more than in the previous quarter, primarily due to the Ivax purchase's roughly $10b. total contribution. Tax reforms led to a $3.6b. rise in net investments in the negotiable shares portfolio, due to adjustments by both institutional and individual investors. Banks increased purchases of foreign bonds and deposits in foreign banks during the first quarter, while increased foreign currency deposits by corporations and individuals and foreign currency credit redemptions by the business sector (as the interest rate gap narrows) led to a surplus of foreign currency sources among Israeli banks.