Stronger Shekel Helping Curb Gasoline Price Increases

Bank of Israel Governor Stanley Fischer shocks the market by raising interest rates for April by 0.5%, to 3%.

Bank of Israel Governor Stanley Fischer shocked the market last week when he raised interest rates for April by 0.5%, to 3%.

The rate increase, combined with the bank's higher forecast for 2011 growth - 4.5%, up from 3.8% - brought a new speculative attack on the shekel, due to the shekel's significantly higher interest rate compared with those of all other major currencies, including the dollar, the euro, the yen and the British pound.

Yet the strengthening shekel partially countered the increase in oil prices - if the shekel hadn't gotten stronger, Israelis would be paying even more for gasoline in shekel terms, said Dr. Michael Sarel, head of the economics and research department at Harel Insurance and Finance.

Fischer's surprise move left analysts guessing just how low the dollar can go in the next few weeks, and wondering whether Fischer would keep on soaking up foreign currency in an attempt to boost the exchange rate. The dollar lost 2.5% against the shekel last week, closing at NIS 3.47 - its lowest level in two and a half years. It lost 4.2% in March.

On Thursday, the central bank started purchasing more foreign currency, soaking up $250 million, but the move had little effect on the exchange rate. In fact, the central bank's currency purchases are the only force pushing down the shekel - all other forces are pushing upward, Bank Hapoalim analysts said over the weekend.

At this point, however, the country's interest rate is likely to stay steady, said Sarel. Now that interest is 3%, the bank can lower interest rates as a policy tool - namely, if it wants to push down the shekel exchange rate, it can lower interest, he said. It could not do so when rates were lower, he said.

Ron Eichel, head economist at the Meitav Investment House, said he predicted the dollar would hit NIS 3.35. "At a time when everyone around the world is talking about raising interest rates, here we're actually doing it," he said.

Fischer's interest rate policy will certainly be affecting businesses, said Dun and Bradstreet Israel CEO Haim Cohen over the weekend, who predicted that the central bank governor could raise rates another 1% by the end of the year.

Rate increases make credit more expensive for companies, which have to pay higher interest, and they also drive consumers to buy less, since their money is earning more just sitting in the bank.

"Hundreds of businesses are facing unexpected difficulties, and are facing high risk of collapse in the wake of the rate increase last week, even though it was clear that the bank would be raising rates," he said.

Higher interest rates decrease the liquidity of businesses so long as they cannot push off the higher financing costs onto consumers, he said. Businesses that face high competition or very elastic demand cannot necessarily raise prices to compensate for their higher costs, he said.