Bank of Israel's Exit Strategy: Wait for Dollar to Strengthen

The Bank of Israel will continue to intervene in the foreign currency market and buy $100 million each business day, as long as it fears that stopping would trigger a sharp appreciation of the shekel against the dollar.

The central bank has already passed its goal for dollar purchases, economic sources in Jerusalem said yesterday. Its goal was to increase Israel's foreign currency reserves by about $10 billion, to $44 billion. It's done that. Yet the Bank of Israel continues to buy dollars.

The shekel-dollar rate has been around NIS 4.10 to NIS 4.70. The central bank worries that stepping out of the forex market, which has become accustomed to the Bank of Israel's actions, would send the rate tumbling to NIS 3.50 per dollar.

The criterion by which the central bank will gauge its moves is exports. As long as Israel's exports remain 40% or more below the average - which was the case in the first quarter of 2009 and the previous quarter - the central bank will buy. That's because a weak dollar would exacerbate the damage to exporters.

A sharp appreciation of the dollar in world markets could also lead the central bank to cease its purchases, based on the calculation that even a subsequent depreciation would leave the exchange rate at about 4 shekels to the dollar.

Central bank officials are also considering gradually scaling back purchases.

After a meeting in London with the director of the Bank of Israel's research division, Karnit Flug, Citigroup analysts wrote that the bank's current challenge is to find an exit strategy from its forex purchases.

A Bank of Israel official said the central bank would continue buying until it says otherwise: "We had an exit strategy even before we started buying. Possibly the market misunderstood what Dr. Karnit Flug had to say."

The Bank of Israel instituted its practice of buying dollars in March 2008. Its first move, buying $600 million in two installments, took the market by complete shock after a decade of non-intervention.

Following that, the central bank announced more predictable moves. It started with purchasing $25 million on each business day. In July of that year, the central bank, run by Governor Stanley Fischer, announced that it would begin buying $100 million per day, on average. And it has been doing so ever since.