Israel's foreign exchange market has been in turmoil since the start of 2023. The shekel has depreciated against the major foreign currencies and the voices that have been heard calling on the Bank of Israel to intervene on the foreign exchange market are getting louder. In the past two and a half months, the shekel has weakened against the dollar by 4%, a depreciation that can significantly affect inflation in Israel.
Last week it was even claimed that the Bank of Israel had reacted to the turmoil and had started buying shekels. But why does the foreign exchange market interest the Bank of Israel, did the bank really intervene and what would be the consequences of this?
The Bank of Israel is responsible for price stabilization in the country. The central bank can intervene in the foreign exchange market in order to stabilize the price of the shekel against the basket of currencies.
An article previously published by the Bank of Israel explains that there are two main motivations for the central bank's intervention in the foreign exchange market: the first is when there is high volatility in the exchange rate - then the bank's intervention will come in order to moderate and calm the market. Another reason is to minimize deviations from the nominal exchange rate trend - which the bank wants to keep.
The Bank of Israel also has a lot of dollars. The foreign exchange reserves held by the Bank of Israel have risen by more than 8% since September 2022, and the volume of the reserves is about $195 billion, representing 39% of GDP. The bank holds these reserves as a backup for an economic emergency and the collapse of the local currency. When the amount of balances that the bank holds is large and beyond the need for emergency backup, it can sell dollars that it holds, also with the aim of stabilizing and mitigating fluctuations in the market.
Did the Bank of Israel intervene in the market in recent days?
Last week it was claimed that the Bank of Israel had begun to buy shekels although senior economists have told "Globes" that the central bank has not intervened in the forex market.
However, the option for the Bank of Israel to intervene on the forex market is still on the table and has even been presented as a reasonable action to take. "Bloomberg" reports that the last time the Bank of Israel intervened on the forex market and bought shekels was in March 2020 to strengthen the fast depreciating Israeli currency at the start of the Covid pandemic, when the shekel weakened by 10%.
Meitav Dash chief economist Alex Zabezhinsky thinks that the Bank of Israel's has not been intervening in forex trading. He said, "There is no reason for the bank not to announce an intervention in the foreign exchange market, when such an announcement would calm the market and bring stability." In order to know what actually happened, we will have to wait a week until March 6, when the bank will publish data on the foreign currency reserves for the end of February, and so the public will know whether an intervention actually took place.
What are the consequences for an intervention?
Intervention by the Bank of Israel can stabilize the foreign exchange market and bring certainty to the market. But on the other hand, intervention in the foreign currency market has substantial disadvantages. The Bank of Israel has a finite amount of foreign exchange reserves which are kept as security for emergency situations - if the bank sells all the foreign exchange reserves and the shekel does not stabilize sufficiently, it could cause the collapse of the currency.
Prico Risk Management and Investments CEO Yossi Fraiman, "It is important to remember that the present situation has been caused as a result of political effects. Intervention by the bank won't solve this problem and traditionally the bank also does not intervene on the forex market. The bank does not intervene in order to change a trend but in specific instances only."
Oppenheimer Israel co-CEO Harel Gillon thinks that the Bank of Israel will intervene on the forex market in accordance with the situation on the market. The bank's intervention in the market would contribute to the stability of the currency at a time when uncertainty is great. "Big upheavals, such as the ones we are experiencing now, undermine the stability of the foreign exchange market, a market where stability is an extremely important element. Therefore, we see a situation in which the bank will indeed intervene in the market, if the drastic fluctuations continue."
Does this indicate that the shekel is at growing risk?
US investment bank Goldman Sachs believes that the depreciation of the shekel reflects a risk premium of 8% that did not exist two months ago, and does not reflect the variables in the market. "While significant political premium now looks to be embedded in the Israeli currency, risks remain for the shekel over the short run. The broader shekel trend this month clearly reflects not just global developments, but domestic ones," Goldman Sachs said.
In contrast to Goldman Sachs' analysts, Wells Fargo Bank expresses optimism about the shekel and claims that shekel selling that has weakened its exchange rate against the dollar have ended. In recent days, Wells Fargo published a survey estimating that the Bank of Israel would intervene in the foreign exchange market, in order to restore order, and that the shekel would strengthen sharply as a result.
Published by Globes, Israel business news - en.globes.co.il - on February 28, 2023.
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