The shekel is getting stronger, but for the wrong reasons – analysis


Amid the ongoing war between Israel and Hamas, a peculiar financial trend has caught the attention of experts and market observers: the strengthening of the shekel against major currencies. Despite the tumultuous Iron Swords operation in Gaza, the representative shekel-dollar exchange rate unexpectedly fell by 0.47% on Friday to NIS 3.5990/$, reaching its lowest level since July. This counterintuitive phenomenon has spurred an in-depth analysis to uncover the intricate factors contributing to the shekel’s apparent resilience.

Local factors at play

Recent uncertainties surrounding the state budget have raised concerns about fiscal responsibility. In response, Bank of Israel Governor Amir Yaron emphasized the importance of a balanced budget. This, in turn, has led the market to believe that interest rate cuts may face challenges, bolstering the shekel’s appeal.

Ronen Menachem, the chief economist at Mizrahi-Tefahot Bank, pointed to the geopolitical threat from the Houthis in the Red Sea, amplifying fears of inflation due to increased cargo tariffs and higher prices for imported products. In anticipation of potential inflationary pressure, the Bank of Israel is inclined to maintain higher interest rates as a precautionary measure. Furthermore, the Bank of Israel’s ongoing program of selling foreign currency, initiated to stabilize the shekel at the war’s onset, continues to influence market sentiment.

A global perspective

New Israeli Shekel bills are seen in front of an upwards-trending graph (illustration) (credit: HADAR YOUAVIAN/FLASH90)

Dr. Michael Bafman, chief economist at Bank Leumi, noted that as the impact of the conflict diminishes, the Israeli market is reverting to a high correlation with global markets. The strengthening shekel, reduced margins in the corporate bond market, and performances aligning with global stock exchanges all reflect decreasing risk perceptions.

Despite these positive trends, Bafman predicts a cautious approach from the Bank of Israel, delaying the first interest rate reduction until the end of February 2024. This delay is attributed to the central bank’s focus on maintaining financial market stability amid lingering global uncertainties that pose risks for Israel.

Right for all the wrong reasons?

In an interview with The Jerusalem Post, Prof. Dan Ben-David, head of the Shoresh Institution for Socioeconomic Research and an economist at Tel-Aviv University, highlighted the conflicting pressures on the shekel.

“There are conflicting pressures on the shekel,” he remarked. “On the one hand, the government is causing a great deal of economic uncertainty with its coalition money and so on. But the very fact that it’s causing uncertainty, which on the one hand should cause the shekel to weaken, is also causing the Bank of Israel to be wary of reducing interest rates, even though inflation is falling here.”

Drawing a global perspective into the analysis, he continued: “At the same time, in the US, inflation is falling as well. And the Fed has already announced that it’s going to reduce interest rates. So as a result of the reluctance here to reduce interest rates because of the uncertainty caused by the government, the interest rates in Israel are becoming relatively higher than the US interest rates than they were in the past, which makes it much more attractive to invest in Israel with short-term investments that move money to Israel and strengthen the shekel.”

Ben-David also provided insight into the Bank of Israel’s strategic move to buy foreign currency over several years, which now acts as a buffer against shekel devaluation. The Bank’s willingness to defend the shekel, combined with diminishing concerns about external threats, has alleviated the pressures leading to the shekel’s recent weakening, allowing it to start strengthening.

In his own words, Ben-David noted, “The fact that the Bank of Israel was willing to defend the shekel with the mountain of foreign currency that it has, plus diminishing concerns about Hezbollah entering the war, has helped reduce the pressures that led to the shekel weakening.”

The shekel’s resilience amidst the Israel-Hamas conflict remains a complex interplay of local and global factors. While the conflict initially introduced uncertainties, strategic financial measures and shifting market dynamics are steering the shekel towards unexpected strength, though that strength may be coming as a result of greater instability at a governmental level.