Bank of Israel Steps into Forex Market
The Bank of Israel took action in the foreign exchange market for the first time since 2022, buying $801 million in May to curb the swift rise of the shekel, as detailed in the central bank’s latest reserve report.
The bank indicated that these purchases were intended to ensure “the orderly functioning of the market.”
This intervention comes amid widespread criticism from business leaders and policymakers, who argue that the shekel’s recent surge to a 33-year high against the dollar is adversely affecting exports, which are vital for economic growth. The strong shekel is compelling exporters and startups to make tough choices regarding hiring or even relocating R&D operations outside Israel, which raises concerns about future economic prospects.
Jonathan Katz, chief economist at Leader Capital Markets, shared with The Israel Times that despite the central bank’s firm policies up to this point, there’s been a noticeable flexibility from the Bank of Israel to manage the shekel’s strength. He suggested that further market interventions might be on the horizon.
While the central bank didn’t specify when the purchases took place, market analysts believe the intervention likely occurred at the end of May, following a brief dip of the shekel below 2.80 to the dollar, pushing it toward that 33-year high.
Following the central bank’s actions, the shekel is thought to have depreciated by about 4.6% against the dollar last week. By Friday, it was trading around 2.94 NIS per dollar, and it’s worth noting there’s no Forex trading on Sundays.
Modi Shahrir, chief strategist at Bank Hapoalim, mentioned that it seems the Bank of Israel continued to buy foreign currency into early June, particularly given the sharp drop in inflation expectations over the past couple of weeks and the shekel’s ongoing strength until recently.
Local manufacturers and exporters have voiced their frustration with Governor Amir Yaron, arguing that his measures to address the shekel’s rise have been insufficient and overdue. The shekel has appreciated about 20% against the dollar over the past year, posing risks to economic growth, prompting calls for bigger interest rate cuts and market interventions.
Shahrir expressed concern that the strong currency could harm high-tech sectors and industrial exports, which are crucial for economic stability, employment, and tax revenue. He noted that while the immediate effects might not be fully visible, they will become apparent over the coming months.
“If a strong shekel negatively impacts exports, it also poses challenges for economic growth, which is a primary aim of the Bank of Israel,” Shafrir pointed out.
The Bank of Israel has various tools at its disposal, the primary one being interest rates. Currency buying and selling can also be utilized to address the impacts of a strong or weak shekel on inflation and economic activity. Typically, the bank aims not to steer the shekel-dollar exchange rate but seeks to intervene during extraordinary market fluctuations.
The last time the Bank of Israel intervened in the forex market was during the COVID-19 pandemic, when it announced plans to purchase $30 billion to offset the swift rise of the shekel and mitigate the economic fallout from that crisis.
At the end of May, the central bank reduced borrowing costs from 4% to 3.75%, marking its second rate cut this year. The bank had maintained rates in its last two meetings in March and February after previous cuts in January and November.
An elevated shekel tends to exert deflationary pressure, as it lowers import costs and curbs price hikes. This enables the Bank of Israel, which is focused on maintaining price stability, to lower interest rates. Recent data showed that annual inflation remained steady at 1.9% in April, comfortably within the targeted range of 1-3%.
Shahril observed that while the shekel appears slightly overvalued, merely cutting interest rates won’t weaken it. He believes that intervention via foreign currency purchases is essential for effective results. However, the decrease in inflation opens up opportunities for the Bank of Israel to engage in forex activities.
It’s difficult to imagine the Bank of Israel allowing the shekel-dollar exchange rate to drop to around 2.50 shekels per dollar, as that would likely be unsustainable in the short run, he added.
Yaron hinted during a recent conference that if inflation continues to decline amid a hopeful cease-fire with Iran and decreasing global energy prices, the pace of interest rate cuts could pick up.
As inflation expectations dip, and especially as they approach the lower end of the target range, a more accommodative monetary policy could be justified, he stated.
Yaron noted that prior interest rate decisions took into account various conflicting geopolitical risks, including warfare, treaties, and fluctuations in energy prices.
He pointed out that Israel’s risk premium is decreasing due to optimism regarding a potential agreement with Iran, which has further lowered inflation expectations.
