By Steven Scheer and Ari Rabinovitch

JERUSALEM (Reuters) -The Bank of Israel left interest rates unchanged on Monday citing signs inflation is easing, but its decision was overshadowed by a report - denied by the central bank - that its governor was set to announce he would not seek a second term.

As expected, policymakers kept the benchmark rate at 4.75% for the second meeting in a row, its highest level since late 2006. It had paused at its July 10 meeting after raising short term borrowing costs at 10 consecutive meetings from April 2022, an aggressive tightening cycle that took the main rate from 0.1%.

The central bank had earlier denied a report by one of Israel's two main radio channels that Governor Amir Yaron would say on Monday that he will not seek to stay on when his current term expires at the end of the year.

"The report this morning by Army Radio that the governor will deliver his decision today regarding the extension of his term is incorrect," the Bank of Israel said. "As he has said until now, the governor will deliver his decision on extending his term around the (Jewish) holiday season."

The high holiday season this year is Sept. 16 to Oct. 7.

The issue of whether Yaron will seek or be reappointed for a second term has loomed over financial markets for months.

Them Israeli-born U.S. finance professor, who was nominated by Prime Minister Benjamin Netanyahu in 2018, has been critical of the economic impact of a plan by Netanyahu's government to overhaul Israel's judicial system.

He has also clashed with lawmakers over sharp interest rate increases that have boosted bank profits while hurting mortgage holders.

After keeping rates steady - a break with the U.S. Federal Reserve which raised rates in July - the central bank said economic activity remains strong, with a tight labour market. Inflation is broad and high but appears to be slowing.

Many economists believe the hiking cycle is over and that the Bank of Israel will start rate cuts in 2024. The central bank said on Monday, however, that it still saw a real possibility of having to raise in the future "if the inflation environment does not continue to moderate as expected".

Israel's annual inflation rate dropped to 3.3% in July from 4.2% in June, its lowest rate since March 2022 but above a government target range of 1-3%.

"The tone of the statement was overall neutral but with one hawkish element: the 'real possibility' of further rate hikes reference was not yet removed," said Citi economist Michel Nies, who sees a rate cut in early 2024.

Part of the path of inflation depends on the shekel, which is at a 3-1/2 year low versus the dollar. The exchange rate, which the central bank has said has a pass through of up to 20% on inflation, has weakened more than 8% so far in 2023.

It was down 0.5% to a rate of 3.815 per dollar in late afternoon trading.

"The shekel's depreciation in recent months is contributing to the increase in the inflation rate and the path of the exchange rate in the coming months will have an impact on the dynamics of inflation," the central bank said.

Israel's economy meanwhile grew at a faster than expected 3.0% annualised rate in the second quarter from the prior three months.

(Reporting by Steven Scheer and Ari Rabinovitch;Additional reporting by Maayan Lubell;Editing by Catherine Evans and Angus MacSwan)