Bank of Israel Believed Unlikely to Set Floor for Dollar Exchange Rate

Central bank seen set to continue its 'ambiguous’ foreign-currency policy.

Meirav Arlosoroff
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Meirav Arlosoroff

Despite the U.S. dollar’s 6.8% decline against the shekel last year, the Bank of Israel is expected to refrain from setting a floor below which it would not let the greenback drop, observers say. Nonetheless the central bank has been intervening by purchasing dollars in an effort to nudge it upward. There have been calls for the Bank of Israel to publicly declare that it would not permit the dollar to sink below a minimum level of 3.3 or 3.4 shekels.
The weakness of the dollar against the shekel has been a source of concern for Israel’s export-oriented businesses, whose revenues in shekels are cut on transactions denominated in dollars and have a harder time competing for overseas dollar-denominated business. On the other hand, a strong shekel makes imported goods cheaper, in shekel terms, for Israeli consumers.
The euro also declined in value over the course of 2013 against the shekel, but by just 2.8%, compared to 6.8% for the dollar. The British pound lost about 5% of its value against the shekel last year.
Against a trade-weighted broader basket of 28 currencies, the shekel was also strong, gaining 7.5%. This is the best measure of the actual strength of the shekel, because it takes into account all of the major currencies in which Israel conducts trade based on their relative importance to the Israeli export market. By contrast, if the dollar sinks in relation to all of the world’s major currencies, the weakness of the dollar alone does not have the same effect on Israel’s trade. The strength of the shekel against the basket of currencies is of particular concern for its impact on the profitability of Israel’s traditional export industries, which employ 35% of the country’s industrial workforce. Profit margins in these industries are generally relatively small.  
Although the central bank has routinely purchased dollars to prop up the American currency against the shekel in the past five years, on Thursday the Bank of Israel intervened to an unexpectedly major extent, apparently buying $250 million to $300 million, after the dollar sank to 3.46 shekels. The central bank is also thought to have intervened on Friday, when the dollar rose above 3.5 shekels. Friday’s representative rate was set a smidgen higher, at 3.504 shekels to the dollar.
The surprisingly large invention on Thursday, during a relatively routine trading day, was seen as a sign that the Bank of Israel will continue to pursue an ambiguous foreign exchange policy, with the purchase of dollars coming by surprise rather than based on explicit, publicly known criteria. It appears that Bank of Israel Governor Karnit Flug, the successor to Stanley Fischer, who retired in June, does not intend to break from the policy of the past five years or so of periodically intervening in the currency market without proclaiming that the dollar would not be permitted to sink below a minimum level.
Presumably the bank is refraining from making such a declaration because it would require a commitment to purchase unlimited quantities of dollars to prop up the U.S. currency and achieve its stated goal. Theoretically the bank could purchase unlimited quantities of dollars simply by printing more shekels. Excessive purchases of the dollar would entail a major expense to the bank, however. The central bank earns less interest on dollars than it pays on shekel-denominated loans to pay for them. That interest rate discrepancy imposes a loss on the central bank and indirectly on the country as a whole.
The strong shekel has prompted calls for a return to the policy in the 1990s, when the shekel’s value was allowed to fluctuate within a set range, beyond which the Bank of Israel had to intervene to nudge it back into line. Currently, by contrast, the bank’s goal appears only to be to prevent major volatility of the shekel’s exchange rate and to moderate the pace of any change. That apparently was the reason for the major intervention on Thursday, after the dollar dropped against the shekel for no apparent reason that was of a more global nature, involving the dollar’s value against the world’s major currencies.
The call for the Bank of Israel to set a limit on the shekel exchange rate follows similar successful policies in Switzerland and the Czech Republic. But both countries took the step in the face of a foreign-currency picture that was much more extreme than what Israel is facing and both have come in for criticism for the policy. The Swiss franc gained 26% against the euro in the two years before a floor was set. The Czechs, meanwhile, were struggling with deflation; their policy shift was aimed at reigniting local demand.
With reporting by Shelly Appelberg.

Bank of Israel headquarters in Jerusalem. The central bank is due to decide on July 28 whether to lower its base lending rate from 0.75%.Credit: Tomer Appelbaum

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