Israeli Central Bank Can Battle Shekel Gains Without Exchange Rate Floor, Official Says

In one of the world's strongest performances, Israel's currency appreciated 9 percent against the dollar in 2013.

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The Bank of Israel remains committed to fighting shekel strength through its current policy of intervention but capping the value of the currency as some other countries have is not appropriate right now, a senior official said."

In one of the world's strongest performances, Israel's currency appreciated 9 percent against the dollar in 2013. More importantly to the central bank, it gained 7 percent versus a key basket of currencies.

Its current level of 3.49 per dollar is a 2-and-a-half year high, prompting complaints by exporters about their ability to compete and starting a public debate whether to put a floor under the exchange rate like in Switzerland and the Czech Republic.

"We continue to intervene in the foreign exchange market ... and sometimes it is to remind the market of that," said Andrew Abir, the Bank of Israel's head of market operations, noting markets have short-term memory. "You have to put a little money on the table to remind people."

He said that while the bank was not ruling out a floor in any circumstances, it did not seem appropriate for Israel. Switzerland capped the value of the Swiss franc in 2011 after it had appreciated 35 percent versus the euro since 2007 and feared deflation. Similarly, the Czechs last November pledged to sell crowns to keep the currency around 27 per euro in a bid to boost the economy and ward off a deflationary threat.

"These are not conditions relevant for Israel," Abir said in an interview with Reuters on Wednesday. "We look at every policy tool and decide whether it's appropriate given the economic and financial markets situation."

Between May and the end of 2013, the central bank managed to stem the pace of appreciation with lower amounts of intervention than in 2008 and 2009, he said. The bank stepped up foreign exchange purchases this month when the shekel started to appreciate again.

"What would the exchange rate have been had we not been in the market? Most people would agree that had the central bank not been in the market the exchange rate would have been in a different place than today," Abir said.

The central bank does not disclose individual purchases but dealers believe it has intervened with several hundred millions of dollars following Monday's decision to keep its benchmark interest rate a 1 percent for a fourth straight month.

Natural gas

Since 2008, the Bank of Israel has bought more than $50 billion of foreign currency to bring its forex reserves to nearly $82 billion.

Abir noted that it is difficult to explain why the shekel gained so much last year since the interest rates gap between Israel and other countries has narrowed while Israel's per capita gross domestic product growth advantage also narrowed compared to the United States and Europe.

The start of natural gas production at the large Tamar well off Israel's Mediterranean coast was a key factor but the central bank introduced a programme to prevent an onset of "Dutch Disease" from the discovery of the gas.

The bank bought $2.1 billion of foreign currency in 2013 and plans to buy $3.5 billion more in 2014 to offset the gains in the current account balance that would boost the shekel. It is estimated it will buy a similar amount in 2015 as this year.

Abir noted the Bank of Israel was planning to buy foreign currency through the gas program until at least 2018 when a sovereign wealth fund would be in place.

Steady foreign direct investment of some $10 billion annually was another factor in the shekel's strength last year.

Most of the shekel's 2013 gains came in the first five months of the year - before intervention in its natural gas program and prior to three interest rate reductions.

Based on internal and external models, "the shekel comes out as over-valued," Abir said.

"The fact that we are intervening means we recognize that the shekel has appreciated beyond the level that can be explained away by fundamentals," he added. Central banks, he said, typically intervene against the trend which makes it harder. "Intervention can certainly change the pace of a trend," Abir said.

But despite disappointment from exporters at the nature of the bank's actions, Abir said the central bank has to look at the economy as a whole.

"When we look at the overall economy we have to choose the right policy mix for the whole economy and not just one sector," he said. "It's not just exports and the whole tradable sector we look at."

Bank of Israel headquarters in Jerusalem.Credit: Bloomberg

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