Bank of Israel Purchases Dollars, Intervenes in Foreign Currency Market

The Bank of Israel intervened in the foreign currency market yesterday for the first time since 1997 and bought dollars. The move surprised almost everyone in the financial markets given that central bank governor Stanley Fischer, as well its foreign currency department head Barry Topf, had previously said the possibility that the bank would intervene was unlikely, and would only occur if there was a market failure.

The Bank of Israel stubbornly refused to say how many dollars it had purchased. Its simple, short announcement said: "The Bank of Israel says that in light of the exceptional behavior of the shekel exchange rate in recent days, the Bank of Israel has purchased foreign currency during trading."

The bank also refused to say whether it would continue to intervene in coming days.

Yesterday, after starting the day at NIS 3.482, the shekel strengthened 3% against the dollar, and reached NIS 3.35, its lowest level since 1997. After the central bank started buying - and the action became known - the dollar rebounded by over a percent to NIS 3.43.

Estimates are the bank bought $100 million.

Fischer made the move without consultations, and clearly wanted to signal to foreign currency traders that from now on there is anther player in the game, though nothing in his actions or statements promised he would do so again.

The intervention caught the Finance Ministry by complete surprise. Finance Minister Roni Bar-On and other senior officials refused to comment yesterday.

"It doesn't matter any more what the shekel does against the dollar - but what the shekel does against the euro and the yen," said the investment manager of one of the branches of a foreign bank operating in Israel yesterday. His comment reflected how little relevance the dollar now has to the strength of the Israeli currency, as a result of the steep declines in the American greenback in recent months.

Yesterday, the shekel also rose against almost all other currencies: the euro-shekel exchange rate fell 1.7% to NIS 5.25, and the British pound lost 1.5% yesterday against the shekel to a representative exchange rate of NIS 6.92.

Nevertheless, there is a difference between the dollar and European currencies in past months in relation to the shekel: against the euro the shekel has stayed stable in the last year.

The proof is in yesterday's events. Even though the shekel gained against both the euro and dollar yesterday, the euro still hit a record high once again against the dollar, which has lost 50% of its value against the unified European currency since 2000.

Even the Fed's announcement of its $200 billion borrowing plan for U.S. banks, which stirred Wall Street to 4% gains on Wednesday, did not impress foreign currency markets.

The dollar exchange rates here in Israel, and all around the world, seem to be heading in one direction only. True, a probable interest rate cut next week by the Fed along with its bond lending program should help raise the dollar sooner or later by strengthening the American economy, but for now there seems to be no end in sight.

The Fed's choice of method to provide funds has been questioned. It is not at all clear that the large banks will take the new funds and pass them on, but instead may simply suck the billions into the huge financial holes opening up in their credit portfolios.

It seems that foreign exchange markets are preparing themselves for the expected 0.5% interest rate cut from the Fed next Tuesday. This will reopen the gap between U.S. and Israeli rates to 1.25%.

Fischer will announce his interest rate decision for April only on March 24. It is clear that the pressure on Fischer from the business sector, in particular manufacturers and exporters, to lower this gap between the dollar and the shekel will only increase as that date comes closer.

The February CPI, to be announced on Sunday, is expected to be critical in influencing Fischer's decision. A low consumer price index, reflecting lower inflationary pressures, will allow Fischer to listen to exporters' claims and lower short-term interest rates by another 0.25%.

Things were no better for the dollar around the world yesterday, as the greenback fell below 100 yen for the first time since 1995.

The results of the U.S. credit crisis, no longer confined to only the subprime mortgage market, and combined with economic statistics indicating a recession, has brought the dollar to new lows against many world currencies including the euro. The yen-dollar rate yesterday was 99.77 and for the euro 1.5624.

There were expectations that the Bank of Japan would intervene in foreign currency trading, as the rise of the yen makes Japanese companies less competitive in world markets, as they are very much dependent on export markets. The Japanese central bank has intervened in currency markets only four times since 1995, each time when the yen crossed the 100 yen to dollar barrier.

Since June 22, 2007 the yen has gained 24% against the dollar. Citi forecasts the dollar will fall to only 95 yen per dollar.