Bank of Israel sits by as shekel strengthens

Amir Yaron  / Photo: Rafi Kotz, Globes

Despite the shekel trading at its strongest against the dollar since 2008, the Bank of Israel is not expected to intervene.

The strengthening of the shekel against the dollar is breaking new records (at least since 2008) and this time the appreciation of the Israeli currency does not look temporary. The fact that the Bank of Israel is not going out of its way to halt the strengthening of the shekel demonstrates that the central bank thinks that the shekel's gains are justified and is not impacted by speculative forces.

Beyond that, the fact that Israeli exports are not showing any signs of weakening despite the strength of the Israeli currency can also have stimulated a rethink at the Bank of Israel about a change in its policy of intervening in the foreign exchange market - a policy that was created and implemented, first and foremost, to protect the competitiveness of Israeli exporters.

The Bank of Israel set the shekel-dollar representative rate today down 0.149% at NIS 3.339/$ - a level not seen since July 2008. This was just before the peak of the global financial crisis and the rate only remained there for a brief period. Before that you have to go back to the start of 1997 to find the shekel-dollar exchange rate at that level.

However, this time the shekel is not expected to weaken against the dollar any time soon and certainly not in the short term. As in years gone by, all eyes are focused on the Bank of Israel to protect the shekel from becoming too strong and damaging exporters.

The current Bank of Israel Governor Prof. Amir Yaron has been taking a dynamic approach with intervention restricted only to conditions that indicate that the shekel has exceeded its correct value on the markets. The fact that the Bank of Israel has not yet officially spoken out on the topic suggests that it is not unduly worried about the shekel's current exchange rate. There are the strongest indications expressed in foreign currency trading that no exceptional intervention by the Bank of Israel is being felt. Since the start of 2020, the Bank of Israel has purchased $15 billion in foreign currency, a relatively large amount, but market traders have not noticed exceptional dealing in recent days.

What does the Bank of Israel's inaction stem from? We can only estimate that the Bank of Israel believes that the shekel is at a reasonable exchange rate in light of the forces currently strengthening it. These factors include external processes like the dollar's weakness on global markets as well as domestic factors like the response of institutional investors to the sharp rises on foreign stock markets and the fall in imports. But the most interesting phenomenon - to which the Bank of Israel is surely not indifferent - is the resilience shown by Israeli exports in recent months, despite the powerful combination of a global economic crisis and a strong shekel. This impressive resilience might limit the future desire of the Bank of Israel to intervene on the foreign currency market 'to benefit exporters."

The primary and main factor behind the shekel's strength is not related to the currency at all but is due to the weakness of the dollar worldwide. The dollar has lost 10% against the euro since April while the nominal effective rate (against a basket of major currencies reflecting the relative weight of Israel's trading partners) of the shekel has remained stable. True that 70% of Israel's trade contracts quote US dollar prices, but the nominal effective rate, nevertheless, has major significance in testing the relative competitiveness of Israeli exports against the exports of countries other than the US.

Mizrahi Tefahot Bank (TASE:MZTF) chief strategist Modi Shafrir said, "The dollar is weakening worldwide because of the risk-on trend, the rise of markets after the US elections and due to the effectiveness of the vaccinations for Covid-19. Investors worldwide are pulling out of their investment in dollars (which are a kind of haven currency) in favor of investments in emerging markets and riskier investments, in anticipation of a more rapid return to routine." Another reason remarks Shafrir is the huge deficit in the US balance of payments, which also weighs on the dollar.

The basic forces supporting the strong shekel have not changed. The structural current account surplus is stable. The scale of direct investments in Israel has even recorded a rise in 2020. On the other hand, imports to Israel have fallen strongly in recent months because of the crisis, the lockdowns, the halt of tourism for Israelis wanting to travel overseas and the substantial fall in online purchases from abroad.

The final factor, which isn't much talked about, is the costs of foreign securities markets. The current rises, which began on the eve that the US presidential election results were published, has paralleled the falls in the dollar exchange rate, and a long-term examination shows that the correlation has continued throughout the Covid-19 crisis. When Wall Street's S&P 500 Index plunged in March, the shekel weakened sharply, but since then the constant rise of the shekel has matched the continual climbing of the market.

Institutional investors in Israel hedge their foreign currency exposure - so that when the overseas stock markets rise, together with them, so does the weight of foreign currency nominated shares and bonds in the portfolios managed by the pension funds and other long-term savings institutions. When the weight of foreign currency assets in a portfolio rises, the institutions are forced to sell dollars in order to reduce their exposure to foreign currency, in order to comply with the exposure policies defined by each of the institutions. As of the end of September 2020, the basket of institutional assets totaled $563 billion. Shafrir estimates that the overall exposure to foreign currency (including shekel and foreign currency derivatives) amounts to $99 billion, about 20% of the total portfolios. A change of 15% higher or lower of this amount equals the annual value of the Bank of Israel's foreign currency market interventions.

Published by Globes, Israel business news - en.globes.co.il - on November 23, 2020

© Copyright of Globes Publisher Itonut (1983) Ltd. 2020

Amir Yaron  / Photo: Rafi Kotz, Globes
Amir Yaron / Photo: Rafi Kotz, Globes
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