U.S. Dollar Breaks NIS 4 for First Time in Three Years

Analysts see continued shekel weakness as foreign investment cools and Israel's trade deficit widens.

For the first time since May 2009, the dollar traded on Wednesday at over NIS 4 as developments in the United States added to concerns about interest-rate cuts in Israel and the country's widening budget and trade deficits.

The dollar's representative rate was set at NIS 4.008.

Over the past 12 months, the greenback has gained 15% against the shekel. The depreciation of the shekel gained momentum following comments by U.S. Federal Reserve Chairman Ben Bernanke, who told the Senate Banking Committee he would ease off on quantitative easing - a policy designed to expand the money supply when adjusting interest rates isn't possible.

Quantitative easing would be expected to weaken the dollar. Bernanke, however, assured the committee that he was ready to take additional steps to stimulate the U.S. economy.

Following Bernanke's remarks, the dollar rose not only against the shekel but against most of the world's major currencies. It climbed 0.5% against the euro to $1.223.

"The hurdle of quantitative easing is still high, and we don't expect to see the Fed taking such steps at this time," said IBI Investment House's chief economist, Rafi Gozlan.

"At the Fed's last meeting, they already decided on broad steps to replace short-term bonds with long-term ones. If we see the bank taking additional broad steps, we expect a substantial drop in inflationary expectations or a decline in the stock market."

The shekel's value against the dollar was also affected by Israel's inflation figures for June, released this week. They showed a surprising drop in prices - by 0.3%. This reinforced the sense that the Bank of Israel could lower interest rates in the coming months, which would also tend to weaken the shekel.

"As soon as investors believe that the interest rate will go down, it supports a decline in the shekel," Gozlan said. But he added that local interest rates are only one factor in the dollar's rise, which was mainly affected by global factors. "Going over NIS 4, when it comes down to it, is a psychological threshold, not more than that," he said.

Also, the prospect of a larger budget deficit looms if approval of the 2013 budget is deferred due to impending elections. The government has already decided to raise the deficit next year to 3% of gross domestic product. An expanding deficit would tend to weaken the shekel, too.

The deputy director of the economics and research department at Harel Insurance and Finance, Ofer Klein, said he expects the shekel's weakening to continue in the short term.

But he thinks that, perhaps even within a year, the currency will strengthen against the basket of currencies of Israel's major trading partners.

He pointed to local factors strengthening the dollar against the shekel, including Israel's geopolitical situation, which scares away foreign investors worried about an attack on Iran, for example. This means that fewer investors are exchanging dollars for shekels.

Klein also noted increased government regulation, which he said would motivate Israeli institutional investors to shift funds abroad.

The growth in Israel's trade deficit also leads to a weaker shekel, Klein noted.

"The demand for what we import is more rigid than the demand abroad for Israeli exports," he said. Klein cited, for example, fuel, which Israel is importing in increasing quantities due to the cutoff of natural gas from Egypt after the regime change there.

"This demand is rigid in the short term. On the other hand, we export high-tech products, demand for which is more flexible in the short term," Klein said.

"So during a period of crisis, exports decline more quickly than imports, and our trade deficit widens. This means more dollars flowing out of the economy than coming in - a phenomenon that weakens the shekel."

Klein also mentioned external factors weakening the shekel, saying the world economic crisis had spurred a flight to the dollar as a safe haven. "Even if the American economy isn't taking off, the situation there is good compared to Europe," he said. "The worse the global crisis gets, the more the shekel will depreciate."

Still, Klein also describes a scenario under which the shekel would strengthen.

"The real devaluation of the shekel enhances the competitiveness of Israeli exports, as the Israeli worker becomes cheaper than those abroad," he said. "After this, local production and exports rise and grow faster than imports." And he noted that the natural gas recently discovered off Israel's coast is expected to support a higher shekel in the future.