Central Bank Surprise / A Risky Step That May Not Work

For the past 11 years Bank of Israel officials prided themselves that our currency market was completely unregulated. Until yesterday. Until the bank's governor broke and decided to intervene.

In recent days, Bank of Israel officials saw "unusual behavior in the exchange rate." The revaluation rate accelerated and the shekel became stronger, not only versus the dollar but also against the other currencies such as the euro and the yen. Also, the currency's standard deviation (which is used for evaluating risk) had risen significantly in recent days.

Stanley Fischer told bank officials during deliberations that the market seemed to have lost its anchor, and that the rate was dropping beyond any reasonable estimation of the value of the shekel. He said this was part of a "herd effect" that occurs when there are large sales without noticing the price. So he decided to intervene.

The intervention suggests that the bank is not only worried about inflation. The direct manipulation of the exchange rate proves that the governor is also concerned about exports and economic growth. As far as inflation is concerned, there is no problem if the dollar continues to sink. On the contrary.

Does the significance of this intervention mean that the governor will not allow the exchange rate to drop below NIS 3.35 per dollar?

Not necessarily. The Bank of Israel realizes that it is impossible to block the law of capital in the long term. They know that the bank lacks the strength to alter the trend in the market. All they wanted was to deal with the "market failure" that took place in recent days.

But this intervention may boomerang on the bank.

Because now, anyone who waited on the sidelines with a bunch of dollars will say that this is the time to sell; after all, the Bank of Israel intervened.

For example, the CFOs of large companies, mutual funds and provident funds who are holding large dollar investments abroad may try to sell their dollars now, hoping that the bank will buy them at the current price to forestall a further drop. In other words, this is a risky step that is not guaranteed to succeed.