* Fischer sees U.S. Fed's QE2 as necessary
* Doesn't want automatic link between inflation, rate hikes
* Israeli domestic demand strong, exports weak
(Corrects second graph to "fundamentally misplaced" criticism of QE2)
By Steven Scheer
JERUSALEM, Nov 15 (Reuters) - Rising inflation expectations remain a concern for policymakers but they do not have to be dealt with immediately, Bank of Israel Governor Stanley Fischer said on Monday.
Fischer also dismissed as "fundamentally misplaced" the criticism of a decision by U.S. Federal Reserve chairman Ben Bernanke to buy hundreds of millions of dollars worth of assets.
Fischer, who was Bernanke's thesis adviser, said a temporary weakening of the U.S. currency was worth boosting growth of the world's largest economy.
Israeli inflation hit a 2.4 percent annual rate in September and is expected to move to about 3 percent in the next year to reach the top of a government target of 1-3 percent.
"That's a matter of concern and we will watch it closely," Fischer told reporters. "We will have to react at some point but it's not a concern that we will have to deal with immediately."
The Bank of Israel has already raised its benchmark rate by 1.5 percentage points to 2 percent since August 2009 to quell higher inflation stemming from surging housing prices.
The last rate increase was on Sept. 27.
"We don't want to establish an automatic link where expectations of inflation rise in the market and the Bank of Israel responds with the need to start raising interest rates," Fischer said in a conference call.
He said the housing market remains the key risk to Israel's economy since further gains in housing prices could lead to a bubble and it could ultimately burst. Fischer believes more allocation of supply is still the best way to lower prices than the Bank of Israel raising rates and using other steps.
Israel's economy, he said, was growing a very respectable growth rate of a little less than 4 percent, fuelled largely by strong domestic demand while exports have turned negative. Exports comprise more than 40 percent of economic activity.
"If the global economy remains weak, we will have to base our economy more on domestic activity," Fischer said, adding that the decline in exports will result in a narrower current account surplus in Israel's balance of payments.
He noted that with countries -- such as the United States and some in Europe -- representing 70 percent of Israeli exports were growing more slowly than expected exporters need to increase sales to Asia, Latin America and Africa.
BACKS BERNANKE
Fischer hinted that many countries around the world were hypocritical in their criticism of Bernanke's decision to buy up to $600 billion of U.S. debt in what is called quantitative easing II (QE2).
"This (criticism) is fundamentally misplaced," said Fischer, adding that the U.S. economy was growing slowly, unemployment was high and there was no chance to use fiscal policy to get the economy to grow faster.
"If I had to choose ... with having to deal with a situation in which the U.S. is growing more rapidly and management of our exchange rate is more complicated and another situation where the U.S. economy continues to grow more slowly and we don't have a problem keeping the exchange rate at the level we like, I would rather have the main engine of growth of the largest economy in the world growing," Fischer said.
The Bank of Israel has bought tens of billions of dollars
the last 2-1/2 years to keep the shekel
Fischer believes the dollar's global weakness is temporary.
"There is some devaluation," he said. "But it's something that will go away as QE2 takes hold and as the U.S. economy returns to growth."
Once there are signs of inflation pressures in the United States, the Fed can reverse its actions by selling assets "and that would be a sign of success of the Fed's policies," he said.