Isranomics

Bank of Israel’s challenge: balancing devaluation, inflation, and uncertainty as shekel hits multi-year low

by | Aug 21, 2023 | Economy | 0 comments

In a significant development, the Israeli shekel experienced a notable devaluation against the US dollar, breaching the NIS 3.80 threshold at the onset of this week’s foreign exchange trading. Although the dollar initially surged to NIS 3.803 – a level reminiscent of its value at the close of 2016 – it subsequently receded and is presently trading at around NIS 3.79.

The ongoing uncertainty caused by the government’s determination to reform the judiciary, resulted in the shekel losing 17% of its value against the dollar since the beginning of the year. Financial experts and industry insiders have weighed in on the situation, offering insights into the potential implications and strategies to address the devaluation. Yossi Freiman, CEO of Prico Group, has pointed out that the relentless weakening of the shekel against the dollar could prompt businesses to take advantage of the favourable rate, which could stop the decline in the exchange rate. The reason for this is that exporters stand to gain from selling foreign exchange at levels as high as 3.80 shekels, a benchmark unseen in the past six years.

However, an underlying stock market weakness could continue to impact institutional investors, leading to further foreign exchange purchases. This dynamic could push exchange rates toward the market’s next critical level, which is currently located at around NIS 3.84.

Given the shekel’s sensitivity to fluctuations in interest rates, the Bank of Israel faces the challenge of maintaining stability. Yossi Freiman suggests that the central bank might opt to expand liquidity through “swap transactions” rather than raising the shekel interest rate. This strategic move could bolster the shekel’s value and potentially curtail the intensity of its devaluation.

Swap transactions involve two parties agreeing to exchange financial assets at a predetermined price on a future date. Additionally, traders use stop loss orders to mitigate potential losses in volatile markets. In the current scenario, traders speculating on the shekel’s strength are expected to activate these orders if the NIS 3.8 per dollar benchmark is crossed, potentially leading to a surge in dollar purchases and a subsequent shekel depreciation.

The ICE’s DXY dollar index, which monitors the dollar’s exchange rate against major global currencies like the euro, yen, and pound sterling, recorded a 2.5% increase over the past month. This factor could also contribute to the shekel’s decline against the dollar.

Furthermore, the ongoing concern of inflation’s resurgence has central banks worldwide on high alert. The Bank of Israel faces a dual challenge of combating inflation and managing the shekel’s depreciation, as the two factors often feed into each other. Governor Amir Yaron of the Bank of Israel estimates that the shekel’s devaluation has contributed to an increase in inflation by about 1%.

As the situation unfolds, the Bank of Israel is contemplating multiple strategies to navigate these challenges. While some suggest tapping into the bank’s foreign exchange reserves, such a move could inadvertently signal economic distress and potentially worsen the situation. The bank’s decision to employ tools like raising interest rates or using swap transactions remains crucial in maintaining economic equilibrium.

For now, the Bank of Israel appears to be taking a cautious approach, allowing market forces to dictate the trajectory of the shekel’s value relative to the dollar. In these uncertain times, effective and well-calibrated strategies will be vital to safeguarding the Israeli economy from the perils of currency devaluation and inflationary pressures.

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