"The Bank of Israel has opened the doors to a stronger shekel," the Bank of America writes in its survey for investors published yesterday. The Bank of America is thereby supporting predictions by a series of foreign banks that the shekel-dollar exchange rate is about to fall below the NIS 3.50/$ barrier. Some of these banks, including the Bank of America, cite the Bank of Israel's interest rate policy, regarded as aggressive by the markets, as one of the factors strengthening the shekel against the dollar.
The Bank of America explains its description of the Bank of Israel's policy as aggressive by analyzing the protocol of the last interest rate decision by the Bank of Israel Monetary Committee on July 8. It cites not only the fact that one of the five committee members supported an interest rate hike, but also that the other four committee members, who supported leaving the interest rate unchanged, stated, "The conditions for another 0.25% increase in the interest rate are likely to emerge in the coming months."
"The Bank of Israel's aggressive attitude towards the shekel opens the door to a further strengthening of the shekel," the Bank of America writes, but adds that the Monetary Committee believes that the Bank of Israel will have to moderate its tone concerning additional interest rate hikes, given the recent inflation figures. The main argument supporting an interest rate hike in the coming months is the annual inflation rate, which was over 1%, putting it within the Bank of Israel's target range for price increases. The June Cost of Living Index, however, published a week after the interest rate decision, lowered the inflation rate in the past 12 months to 0.8% for the first time since June 2018.
The Bank of America believes that the recent inflation figures make another interest rate hike unrealistic. Commenting on the strengthening of the shekel, however, it writes, "There are few indications that the Bank of Israel intends to take action against the strong shekel," for example by intervening in foreign currency trading.
The Bank of America states, "It appears that the Monetary Committee under Governor of the Bank of Israel Amit Yaron's leadership is focusing less on the effect of the strong shekel on the Israeli economy." The Bank of America says that in similar circumstances in the past, previous Governor of the Bank of Israel Dr. Karnit Flug "expressed concern" about possible damage to exports and trade. The Bank of America adds that the Bank of Israel very seldomly intervenes in foreign currency trading, and even halted its program of purchasing foreign currency in order to neutralize the effect of local natural gas production.
These facts, coupled with "the frequent statements by Yaron that the exchange rate should be determined by market forces," lead the Bank of America to the conclusion that "The Bank of Israel's commitment to preventing the strengthening of the shekel is weak."
Other factors cited by the Bank of America as supporting the strengthening of the shekel are the narrowing of the interest rate gap between the US and Israel and the expansive monetary policy in the euro bloc; Israel's balance of payments surplus caused by the power of the high-tech sector; and the beginning of gas production from the Leviathan reservoir towards the end of the year. The Bank of America also notes the activity of investment institutions, which have cut their foreign current holdings by $4.5 billion since the beginning of the year, and the anticipated decision in September to add Israel to the World Government Bond Index (WGBI) compiled by the Financial Times Stock Exchange (FTSE).
Meanwhile the Bank of Israel today set the shekel-dollar representative rate down 0.709% at NIS 3.500/$ and in subsequent inter-bank trading the rate fell a further 0.32% to NIS 3.489/$.
Citibank: NIS 3.46/$
The Bank of America's review is the latest in a series of reviews published by foreign banks in recent days predicting a drop in the shekel-dollar exchange rate below NIS 3.50/$. Citibank, for example, last Thursday predicted that the shekel would maintain its momentum "as a result of a split in the Bank of Israel Monetary Committee (concerning the interest rate decision, A.B.) - meaning that the fact that one of the committee members supported an interest rate hike from 0.25% to 0.50% in the recent discussion. The Bank of America's foreign currency trader in Israel predicts that that the shekel-dollar exchange rate will be NIS 3.46 in the medium term.
In an update for investors published the same day, Deutsche Bank predicts that the current strengthening trend in the shekel will push the shekel-dollar exchange rate down to NIS 3.47/$ in a few more weeks. A review published by Commerzbank senior analyst Axel Rudolph says that the shekel-dollar exchange rate will move in the direction of NIS 3.47-3.48/$, "breaking through the NIS 3.50/$ psychological barrier in the process."
Mizrahi Tefahot Bank chief strategist Modi Shafrir stated in his review this week that the shekel had continued to strengthen despite the June Consumer Price Index, which showed a steeper than expected 0.6% decline, making it less likely that the Bank of Israel would raise the interest rate in its upcoming meeting at the end of August. This developed ostensibly should have halted the strengthening of the shekel, but the shekel has strengthened by 1.15% more against the basket of currencies since the index was published on July 15.
Vacationers saving money, exporters suffering
In the short term, further strengthening of the shekel is in opposition to the usual seasonal trend towards a weaker shekel in July-September, when many Israelis take their summer vacations overseas. For Israelis who can afford a relatively expensive and lengthy trip, a stronger shekel is good news, because they can save hundreds of shekels as a result, and the same is true for people buying overseas products online.
For exporters, on the other hand, the current shekel exchange rate is dealing a blow to their profit, and puts them at risk of losing deals in competition against foreign manufacturers. Manufacturers Association of Israel president Shraga Brosh, who is calling on the Bank of Israel to intervene in foreign currency trading, estimated in mid-June that the strengthening of the shekel since the beginning of the year had reduced exports of goods and services from Israel by $1.4 billion. The trend since then has only exacerbated the difficulties afflicting exporters.
A key contribution to the strengthening of the shekel in 2019 came from the investment houses and insurance companies, which manage the public's long-term savings. According to current figures updated to May published by the Bank of Israel on these institutions' foreign currency transactions, the volume of foreign currency assets held by these concerns has fallen by a cumulative $4.5 billion since the beginning of the year, in contrast to the regular rising trend in their assets.
The volume of the institutions' assets declined by a net $1.7 billion in January, $1.2 billion in February, $700 million in March, and $1.4 billion in April, followed by a miniscule $200 million rise in foreign currency assets in May. The decrease in foreign currency assets is also due to an increase in foreign currency hedging - "insurance policies" purchased by the investment concerns in order to fix the shekel-dollar exchange rate for their investments in foreign currency and protect them from a stronger shekel.
Shafrir says that the effect of the investment institutions' foreign currency policy on the markets goes far beyond their purchases and sales of foreign currency, however large these may be. The reason is that many foreign currency market players, including hedge funds, monitor what the investment institutions are doing, regard them as a factor that determines the trend, and take similar action shortly afterwards.
Shafrir adds that the trend on the part of the investment institutions towards selling dollars and reducing their foreign currency exposure through hedging is the opposite from what prevailed in 2018, when the investment institutions increased their net foreign currency assets by $8 billion. In November 2018, the cost of hedging reached a peak of 3.15% of the hedge amounts per year as a result of the widening of the interest rate gap between the US Federal Reserve and the Bank of Israel, and the shekel weakened against the dollar by 7% in December 2017-December 2018. This year, however, the costs of hedging have fallen to around 2%, and the shekel strengthened by 5.6% against the dollar. "In late 2018, we assumed that the investment institutions would begin reducing their exposure to foreign currency and increase their net hedging," Shafrir writes. "Those who did so acted wisely."
"No change justifying a strengthening of the shekel on this scale has occurred in the basic variables… A mix has been created that supports an increase in speculative activity, until a signal of a change in policy by the investment institutions and/or the Bank of Israel is given," IBI Investment House chief economist Rafael Gozlan writes.
"For the Bank of Israel, given the decline in the inflation rate following the unexpected June Cost of Living Index, and taking into account the global uncertainty, especially where trade is concerned, shekel appreciation both detracts from exports and delays an increase in inflation. In the past, shekel appreciation on the current scale aroused an aggressive response by the Bank of Israel as a signal of discomfort with the exchange rate. We believe that the array of recent developments has greatly increased the probability of renewed intervention in the foreign currency market by the Bank of Israel, which will cause a rise, even if only temporary, in the shekel-dollar exchange rate."
Published by Globes, Israel business news - en.globes.co.il - on July 30, 2019
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