BOI tested in new battle to tame shekel
Central bank may use intervention as its main tool to weaken Israeli currency since lowering its benchmark interest rate, now at 1.75%, could further inflame housing prices, which have rallied 50% in four years
The shekel has gained more than 5% over the past four months against the dollar and the euro, posing a risk to Israel's exports which account for 40% of economic activity.
Japan's recent announcement that it planned to pump $1.4 trillion into its economy in less than two years is seen as a catalyst that will drive capital flows into higher-yielding emerging market assets, prompting the Bank of Israel to step into the market for the first time since July 2011.
Japan's move and weak US jobs data pushed dollar-shekel below what was believed to be a psychologically important 3.6 level for a fresh 17-month low.
Gaelle Blanchard, an emerging markets strategist at Societie Generale, said those events "changed the mood in the market."
"You see the impact in all emerging market currencies. Everything is booming now," she said. "People need to invest money and are trying to find a good place."
The shekel has been one of the best-performing emerging market currencies this year, reflecting Israel's relatively strong economy and high interest rates and expectations that the start of natural gas production last month will improve the government's fiscal position.
After cutting interest rates four times last year, the central bank has kept them steady over the past three months. That suggests it will use intervention as its main tool to weaken the shekel since lowering its benchmark interest rate, now at 1.75%, could further inflame Israeli housing prices, which have rallied 50% in four years.
"They are in a trap," said Tal Zohar, chief executive of forex broker FXCM Israel. "They don't want to reduce rates so not to increase the housing bubble but they want a weak shekel."
Israel's economy and finances are set to benefit from the start of natural gas production last month at the Tamar field off the Mediterranean coast, which will save the country's electricity utility the expense of having to import expensive fuels.
Natural gas production is expected to add 1 percentage point to economic growth this year, which the Bank of Israel forecasts at 3.8%.
Tamar and the larger Leviathan field nearby, which comes online in 2016, will probably export natural gas. The central bank has supported a finance ministry proposal to set up a sovereign wealth fund for income from the two fields to keep the shekel in check in the long run.
Test of resolve
Israel's exports of goods, which mostly head to Europe and the United States, grew only 0.1% last year and leading exporters have been calling for central bank intervention to tame the shekel for some time.
"The intervention was more of a signal than actual policy," Zohar said of last week's action. "What they (the Bank of Israel) are doing is trying to push back the speculators who are weakening the dollar ... They are saying 'we are looking at it very carefully,'" he said.
Since the intervention, the dollar has recovered to NIS 3.64 while the euro has strengthened to NIS 4.76 from NIS 4.66. But dealers say short-term investors have been helping drive the shekel higher and expect them to test the central bank's resolve again.
"It's only a matter of time until they test the bank of Israel again," said a dealer at Israel Discount Bank. "It looks like each side is waiting for the other side to move."
Zohar expects dollar-shekel to move back to 3.70 in the next few months while Blanchard sees it at 3.65 at the end of June.
The central bank said last week it "will act in the foreign exchange market in the event of unusual movements in the exchange rate which are inconsistent with the underlying economic conditions or when conditions in the foreign exchange market are disorderly."
During its last interventions between March 2008 and July 2011 the bank bought some $50 billion of foreign currency, mainly dollars, to keep the shekel in check. Analysts doubt the current round will be so large, particularly as current foreign exchange reserve levels of nearly $80 billion are sufficient.
