The shekel has been gaining against the dollar in recent days. The Bank of Israel set the shekel-dollar exchange rate down 0.315% at NIS 3.480/$ on Friday and the rate is down a further 0.54% at NIS 3.461/$ in futures trading today. Last week the shekel was trading at NIS 3.526/$ - a level not seen since May 2020.
But the past six months aside, the forex trend since the mid-2000s has been the strengthening of the shekel against the dollar and all the world’s major currencies as strong economic growth has boosted the Israeli currency’s purchasing power. The trend hampered the ability of Israeli exporters to sell their goods and services abroad and this resulted in the Bank of Israel intervening on the forex market to purchase foreign currency and moderate the appreciation of the shekel.
Last year the Bank of Israel purchased $35 billion in foreign currency, boosting foreign currency reserves to a record $213 billion in December 2021. But this year the Bank of Israel has halted its forex purchases, marking the end of its expansionist policies, although the strengthening of the dollar worldwide and the sharp falls on Wall Street have been doing the job for the Bank of Israel, and sharply weakening the shekel.
IBI Investments chief economist Rafi Gozlan explains, ‘In terms of the economic situation in the previous decade, there was no need to protect the exchange rate from an overall perspective but it was convenient to protect the exchange rate for the benefit of the engine of the economy - Israeli exports. It’s true that inflation was low but a lot of that was due to supply side factors. Last year the Bank of Israel bought dollars as the economy grew 8% and the question arose as to whether such intervention was necessary? Probably not. If the economy had grown less because of the exchange rate that would have been fine."
The strong shekel, which slowed inflation, changed direction
But if the name of the game in the previous decade was protecting against the strengthening of the shekel, a side effect today in the battle against inflation has been the reverse, with a stronger shekel insulating Israel against inflation. In the previous decade there was no inflation and the story was how to prevent slowdowns and provoking demand by weakening the currency.
However, the rise of inflation has brought with it a rise in interest rates in the US at a pace not seen for years and countries that don’t fall in line with Washington are seeing capital flee abroad and their currencies devalued against the dollar. Since inflation has started rising, central banks are not opposed to the strengthening of their currency because that halts the rise of imported prices but most of the central banks aren’t taking any proactive action on this for the time being.
In Israel too, a strong shekel has the power to halt the rise in prices imported from overseas. But at the same time the steep falls on Wall Street since the start of the year have greatly weakened the shekel, as Israeli institutional investors are forced to sell shekels to hedge the pension funds invested abroad.
Gozlan adds, "When we are talking about the shekel we have to look in comparison to all the currencies and not only the dollar. The basket of currencies was strong until the second quarter this year, when we moved to a situation in which the exchange rate, which was slowing inflation began to contribute to inflation. We are not yet talking about anything too dramatic, because the shekel is still strong. The economy generates a high foreign currency surplus of $30 billion annually, offset by an outflow of foreign currency, mainly from institutional bodies."
Gozlan says that the weakness of the shekel partly reflects a worsening of basic factors like worsening trade conditions and weakness in the tech sector. "But mainly reflects the high correlation between the exchange rate and the US share indices due to the high exposure of Israeli institutional bodies, neutralizing exposure to foreign currency. The weakness in the basic factors is expressed in the moderation of net direct investments. Beyond the expectations for continued declines in tech share prices, it is also reasonable to assume that a worsening of trade conditions will lead to a fall in the current account surplus."
But in contrast to previous currency wars in which the Bank of Israel moderated the strengthening of the shekel by purchasing foreign currency, the opposite process of selling dollars is considered dangerous because of the importance of the foreign currency reserves during a time of crisis. "The exchange rate today was moved aside when the story for some time has been not only imported inflation. The weight of the rise in commodity prices is significantly higher than the increase obtained from the exchange rate. The central banks wouldn't be opposed to having a very strong currency but they are not going to do anything proactive regarding this."
Will summer vacations still be cheap?
Gozlan: "For the euro yes. In Europe the overall price index has risen far more than in Israel. Inflation in Israel is above 4% and in Europe it is around 8.5%. Although the change in prices has been higher over the past year, the starting point from which prices are measured was lower, so it is still cheaper to travel in Europe."
Published by Globes, Israel business news - en.globes.co.il - on July 10, 2022.
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