Why Israel Tries, and Fails, to Slow Its Roaring Currency

(Bloomberg) -- Israel’s shekel has breached significant highs against the dollar this year, prompting the central bank to buy billions of dollars worth of foreign currency to roll back those gains. Nevertheless, the shekel is forecast to keep its momentum.

Here we explain what has been behind the shekel’s strength and the approach policy makers have taken to push back, or prepare the economy for a new normal.

Just how strong is the shekel?

In historical terms, very. The shekel is about 1% from crossing a 24-year high against the dollar. Against a basket of 24 currencies measured by the central bank, the shekel reached the strongest level since at least 1999 on Dec. 10.

Why is it strengthening?

Analysts point to several factors boosting demand for the shekel. Exports keep widening Israel’s current account surplus, which jumped to a record $6.4 billion in the third quarter. Investment in the country’s technology sector is on pace to reach $10 billion this year, another record, with most of the flows coming from abroad. Also drawing foreign inflows are Israel’s recent inclusion into FTSE Russell’s World Government Bond Index and increasing natural gas sales to neighboring countries.

There is one other major contributor: dollar weakness. Investor appetite for riskier assets has accelerated in the past half-year, with ultra-low interest rates and unprecedented economic stimulus kicking off a global hunt for yields. The shekel has gained 6.2% against the dollar this year, but that ranks seventh-best among a basket of 31 major currencies tracked by Bloomberg.

Why does a strong shekel matter?

Israeli central bankers have grappled for years with weak inflation, and they are worried that a significantly stronger shekel will further slow price increases. Officials are also worried that a more valuable currency will damage exports. Local manufacturers want the Bank of Israel to be more aggressive and say they are losing billions in sales abroad.

In contrast though, the currency’s appreciation makes it cheaper for Israelis to travel and shop abroad. Prime Minister Benjamin Netanyahu’s top economic adviser Avi Simhon has been a consistent proponent of a stronger shekel, arguing it would boost employment and wages.

What is the Bank of Israel doing about it?

Because interest rates are already close to zero, policy makers have mainly relied on foreign-currency purchases to curb the shekel. The pace has quickened this year, with the central bank buying about $17 billion worth, the most since 2009. Governor Amir Yaron just promised more.

Policy makers say they want the shekel trading in a range that is consistent with the fundamental state of the economy. Economists are skeptical the central bank can reverse the trend, given the forces propelling it.

What’s the outlook on the shekel?

Economists at global banks expect the shekel to remain close to its present level until the end of next year at least, according to the mean of forecasts compiled by Bloomberg.

“Both the domestic and global cases for shekel depreciation appear to have weakened over time,” Goldman Sachs Group Inc. analysts wrote in a Dec. 17 report. “Though Israeli policy makers would likely push back more forcefully should the current pace of appreciation continue, the shekel can move moderately stronger versus the dollar in 2021.”

©2020 Bloomberg L.P.