During Thursday’s session, the shekel- US dollar exchange rate reached NIS 3.78/$, and it continued to rise on Friday, with the representative rate being set at NIS 3.7930/$. The shekel-euro representative rate was set at 4.1206, 0.19% higher than on Thursday.
Market sources say that, while political divisions in Israel are weighing on the shekel, and the risk premium is around NIS 0.30-0.40, the main factor behind the sharp depreciation of the past month is the situation on world markets, where the US dollar is strengthening.
1. A new psychological level
"The foreign exchange market is a speculators’ market and it reflects management of expectations. Psychology is a key factor here," a source in the financial markets explains, referring to currency investors’ forecasts of where the shekel-dollar rate could go. In the past year, several lines have been crossed, the latest one in the past few days, when the shekel was traded at above NIS 3.75/$, and the market is now looking towards the next threshold.
Every breakthrough of a resistance level further fuels the depreciation of the shekel. If, as it seems, the NIS 3.75/$ level has been finally breached, what comes next? It depends whom you ask. One market player says that the next resistance level is NIS 3.88/$, which was recorded at the height of the Covid-19 crisis in March 2020. At that level, the Bank of Israel intervened in trading, and brought about a sharp change of direction. Another source provides a simpler view: "Look, people like and remember round numbers. It could be 3.8 shekels, or even 4."
2. Impaired decision making
The depreciation of the shekel comes at a tough time for the Bank of Israel. Tackling inflation is a long, weary process, and not popular in some quarters. No-one likes seeing their mortgage or other loan become more expensive time and again as interest rates rise, but the rises are necessary. The alternative, of letting inflation run riot, is dangerous, and itself places a burden on households and mortgage borrowers with index-linked loans.
Central banks are genuinely worried that inflation will raise its head again after a period in which it has retreated. Amid all its efforts to restrain it, the Bank of Israel is also confronted with the depreciation of the shekel, which itself fuels inflation and reduces clarity. Governor of the Bank of Israel Amir Yaron has estimated the contribution of the shekel’s depreciation to inflation at 1%. This means that, were it not for the depreciation of the currency, inflation would by now be within the central bank’s 1-3% target range.
The situation is actually more complicated. It’s very difficult to make a real assessment of the contribution of currency depreciation to inflation. As the Bank of Israel puts it: "When a foreign currency becomes dearer, imported products also become dearer, and, in their wake, products manufactured in Israel as well. Thus depreciation and inflation feed on each other. When inflation is high, since money continues to lose value, the ability to make correct economic decisions is harmed - big, complicated decisions by businesses and financial institutions, long-term decisions by the government, and simple, everyday decisions by each one of us."
3. What can be done apart from raising interest rates?
One of the main questions is: What is moving the foreign exchange market? The following factors are, of course, only hypotheses, but all of them appear to be involved: locals shifting money abroad in all kinds of ways; foreigners no longer investing in Israel as they did in the past, or betting against the shekel; and financial institutions raising their overseas exposure.
The financial institutions’ share is especially significant, and it can be quantified fairly simply. Until the current phase, the rule of thumb was that, when overseas securities markets rise, the currency exposure of Israeli institutions invested in those markets rises accordingly, and so they sell foreign currency, mostly US dollars, and buy shekels, causing the exchange rate to fall. Conversely, when US markets fall and Israeli institutions have to increase their margins (the exposure is partly in futures), they sell shekels and buy dollars, causing the exchange rate to rise. Hence the strength or weakness of the shekel was to a large extent a function of rises and falls in US stock indices.
This year, that formula has not worked as it has in the past. Financial institutions have not rushed to shed dollars even when US stock markets have risen. The reason could be fears of the consequences of the judicial overhaul, assessments that economic conditions in Israel have changed, or other factors.
The question that keeps being asked is: Why doesn’t the Bank of Israel release some of its $204 billion of foreign exchange reserves and calm the markets? The main answer is that this is trickier than it looks, and that such a move would be liable to signal distress, which would boost the appetite for dollars at the expense of the shekel. But the central bank does have other tools at its disposal.
The first, and least popular, is the interest rate. Over time, raising the interest rate restrains inflation, but it also improves the attractiveness of the shekel relative to other currencies. We all know the price of that; among other things the hit to mortgage borrowers.
Market players raised other possibilities. Swap transactions, for example, which, rather than affecting the shekel interest rate, can affect the local dollar interest rate, which is very high, and thus make the shekel more attractive. The Bank of Israel made use of this tool in 2022 during the pandemic period. For the time being, the Bank of Israel prefers to sit on the fence, and let market forces do their thing.
Published by Globes, Israel business news - en.globes.co.il - on August 20, 2023.
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