In first since 2022, Bank of Israel buys foreign currency to stem sharp shekel gain

For the first time since 2022, the Bank of Israel intervened in the foreign exchange market, buying $801 million in May in a bid to curb the sharp appreciation of the shekel, according to the central bank’s monthly foreign exchange reserves report.

The bank said the purchases in May were aimed at maintaining the “orderly functioning of the markets.”

The move comes as a host of business leaders and policymakers have criticized the central bank’s reluctance to act, saying​ the recent 33-year high in the shekel versus the dollar is harming exports, a major growth engine of ​the economy. The strength of the local currency is forcing exporters and startups to make tough decisions about hiring abroad and moving R&D centers out of Israel, stirring fears about future economic growth.

“Despite the central bank’s adamant policy until now, the Bank of Israel is showing some flexibility to stem the appreciation of the shekel,” Leader Capital Markets chief economist Jonathan Katz told The Times of Israel. “With this move, the central bank indicates that we could see more purchases in the foreign exchange market.”

The central bank does not specify the exact timing of the purchases. But market observers estimate that the foreign exchange intervention took place at the end of May as the shekel briefly strengthened below NIS 2.80 per dollar, trading around a 33-year high against the greenback.

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The central bank’s foreign currency intervention appears to have helped weaken the shekel by 4.6 percent against the dollar last week. The local currency is trading around NIS 2.94 per dollar as of Friday. There is no foreign currency trading on Sundays.

“Against the backdrop of the sharp decline in inflation expectations in the last two weeks, and the continued strengthening of the shekel (until last week), we estimate that the Bank of Israel continued to purchase foreign exchange in early June,” said Bank Hapoalim chief strategist Modi Shafrir.

Local manufacturers and exporters have been accusing Bank of Israel Governor Amir Yaron of doing too little, too late, to help moderate continued gains in the shekel, which has strengthened by about 20 percent against the dollar over the past year. Exporters have been warning that the local currency’s strength poses a risk to growth prospects in the economy, calling for a bigger interest rate cut and intervention in the foreign exchange market.

“The big fear is that we will see significant damage to the high-tech industry and industry exports, and then those basic fundamental forces, which are so important to the economy, and are the engines driving employment and tax revenues, will be hurt, and as a result the shekel will weaken but not for good reasons,” said Shafrir. “Early indicators are that the strong currency erodes profitability for exporters, but the wider implications we will only see in the weeks and months ahead.”

“If the strong shekel hurts exports, it hurts economic growth, which is a secondary target of the Bank of Israel — this is the dilemma the Bank of Israel is facing,” Shafrir added.

The Bank of Israel has a number of policy instruments in its arsenal, the main one being the interest rate. It may also buy or sell foreign currency to moderate the negative impact of shekel appreciation (or weakness) on inflation and economic activity. The central bank’s policy is to intervene in the foreign exchange market in response to unusual and irregular market activity, rather than to influence the shekel-dollar exchange rate.

The last time the Bank of Israel intervened in the foreign exchange was around the COVID-19 pandemic when it announced a plan to buy $30 billion to stem sharp shekel appreciation and help ease the economic ramifications of the crisis.

At the end of May, the central bank, led by Yaron, trimmed borrowing costs from 4% to 3.75%, marking the second rate cut this year. In its previous two rate decisions in March and February, the Bank of Israel left borrowing costs on hold, after two cuts in November and January.

The overly strong shekel has a deflationary force, as it makes imports cheaper, restrains price increases and credit costs for consumers, and enables the Bank of Israel, which is concerned about price stability, to lower interest rates. The most recent data showed the annual inflation rate in April was steady at 1.9%, well within the government’s target range of between 1% and 3%.

“The shekel is somewhat overvalued; interest rate cuts alone won’t help to weaken the currency — only in combination with foreign exchange purchases,” said Shafrir. “Nonetheless, the lower inflation will allow the Bank of Israel to act in the foreign exchange market.”

“It is hard to believe that the Bank of Israel will allow the shekel-dollar rate to reach uncharted territories of about NIS 2.50 per dollar, at least not in the short term as it is not sustainable,” he added.

Speaking at a conference last week, Yaron indicated that interest rates could fall at a faster ‌pace if inflation continues to ease amid increased optimism over a ceasefire deal with Iran and lower global energy prices.

“As inflation expectations decline — and certainly if they approach the lower bound of the target ​range — this justifies a more accommodative monetary policy and a faster pace of easing,” he said.

Yaron said the last interest rate decision reflected, ​among other things, a balancing of opposing geopolitical risks: war versus an agreement, rising energy prices versus falling prices, currency appreciation ‌versus ⁠depreciation.

He noted that Israel’s risk premium had continued to decline on the hopes of a deal with Iran.

“All of these developments have further lowered inflation expectations,” Yaron said.

Reuters contributed to this report.