Why the currency basket became obsolete
Contracts may be stated in dollars, but the euro bloc is Israel's true trading target
From May 1, the basket of currencies is dead. The Bank of Israel won't be publishing its exchange rates from then, mainly because the exchange rate had ceased to be followed or serve as an analytical tool since the bank did away with the exchange rate band 18 months ago.
The bank will no longer calculate the rate on an ongoing basis nor update the balance of weighted currencies. It will however continue to release daily exchange rates for the shekel against specific currencies.
The dollar-shekel exchange rate has fallen 11.5% in a year, while the euro has slid just 1.1%. The basket of currencies rate dropped 8.5% during this time, because the dollar was weighted 75%.
The basket of currencies is supposed to reflect the country's foreign trade. Is 75% of its foreign trade conducted in dollars?
No, it is not, says the central bank. Though 75% of contracts are stated in dollars, most of these contracts are done with countries in the euro bloc. The prices are therefore linked more closely to the euro.
Analysts believe the dollar's true share of the trade is 40%, while the euro's stake is about 30%. The dollar has an advantage with exports, but the euro has an edge on imports.
If the shekel's appreciation against currencies worldwide was adjusted to reflect its true trade of balance, it would be significantly less than 8.5%.
The local economy indeed measures itself almost exclusively in dollars, so it sees the 11.5% appreciation over the past year, even if in reality the local currency has strengthened much less.
This dollar orientation has serious consequences for inflation. An artificial reduction of inflation to below the government's target stemmed mainly from the shekel's appreciation against the dollar and the fact that the Israeli economy orients itself toward the dollar and ignores other currencies.
Thus, measuring up against the dollar or a dollar-dominated basket of currencies artificially lowered inflation last year. This drop, needless to say, does not make the central bank comfortable. It led to criticism of the bank for missing its 2006 inflation target.
One can surmise that the central bank is seeking ways to manage this criticism. Among other things it will try to have the shekel reflect a more realistic picture against a true basket of currencies that is not dollar dominated.
The central bank announced that first, it would stop publishing the basket's representative rate. More time is needed to see whether the Bank of Israel will try to publish another rate in its stead, which would give a more accurate expression to the basket of currencies reflecting Israel's true trade.