By Steven Scheer

JERUSALEM, (Reuters) – It took $50 billion and nearly two years for the Bank of Israel to finally accept that it was time to reduce intervention and allow the shekel juggernaut to continue.

The inflation rate is slowly creeping towards the target, which could be something that is changing the equation.

The central bank will not abandon interventions completely, but economists are expecting it to cut sharply on foreign currency purchases. This strategy was established years ago to limit the constant shekel appreciation.

Monday’s shekel reached 3.08 USD, which is the highest price since 1996.

The shekel is currently the best performing emerging currency, rising 10% against the main trading partners since early 2020 when the pandemic began to roil financial markets. Since the beginning of 2020, the shekel has seen a nearly 4 percent increase in value. This makes it one the three most popular emerging currencies for 2021.

This all despite Israel’s 0.1% interest rate not being raised, which is unusual for many developing nations.

(For graphic on Emerging currencies since the start of the pandemic: https://fingfx.thomsonreuters.com/gfx/mkt/dwpkrealzvm/Emerging%20currencies%20since%20the%20start%20of%20the%20pandemic.PNG)

The strength of the shekel can be attributed to many factors, as well as to the weakness of the dollar overall: A rapid economic recovery following the COVID-19 crises and a wide-ranging vaccination program; large current account surplus expected to reach 5.5% GDP in 2021 thanks to Israel’s technology firms; huge foreign direct investments in the sector which may exceed $30 billion in this year.

International stock market gains can also lift the shekel as Israeli pension funds and other institutions have to limit their exposure to foreign currencies. They have had to bring $20 billion in foreign currency into the market.

INFLATION EQUATION

Jonathan Katz of Tel Aviv brokerage Leader Capital Markets stated, “All these factors are there and the Bank of Israel cannot try to stop a sharp shekel appreciation.” He added that it was possible to deduce from statements by Amir Yaron of BoI governor, that he does not want to interfere.

Yaron assumed office late-2018, but he remained on the sidelines for 2019, overlooking an increase of 8% in shekels as well as an outcry by exporters. He intervened when the pandemic required support.

The central bank expects growth of 7% in the coming year.

He believes that, when the economy is in recovery and things are good, then there’s no need to intervene. Katz predicted that the dollar-shekel would be at least 3 dollars by year’s end.

Katz compares Israel’s high-tech boom to that of the country in 2013. In 2013, the BoI bought dollars to try and offset the sector’s effect on the rising shekel. He said that other exporters will suffer if there is not enough compensation for this one sector.

(For graphic on Israel current account and foreign direct investment: https://fingfx.thomsonreuters.com/gfx/mkt/zdpxonrjjvx/Israel%20current%20account%20and%20foreign%20direct%20investment.PNG)

Yaron was seen to be continuing the same path as his predecessors. Their intervention campaigns have increased BoI reserves to 47% of GDP. BoI has announced that they will be purchasing $30 billion worth of forex for 2020, after having purchased $21 billion.

Yaron called $30 billion’s programme last week an “exceptional plan in extraordinary times”. BoI stated that it will not prolong the program and instead would revert to unannounced intervention when economically feasible.

CONCERNS ABOUT EXPORTERS

Modi Shafrir is the chief strategist of Mizrahi Tefahot Bank’s finance division. This follows Israel’s September 2.5% inflation print — which was towards the top end of the bank’s annual 1%-3% target.

Shafrir explained that there was deflation at the beginning of 2021 and that we now have a very different environment. “The inflation from the supply-side is slightly reduced by the shekel appreciation.”

(For graphic on Israel interest rate inflation and the shekel: https://fingfx.thomsonreuters.com/gfx/mkt/gdpzydwjevw/Israel%20interest%20rate%20inflation%20and%20the%20shekel.PNG)

Yaron said last week that the central bank created an environment which allowed the economy’s gradual adaptation and shift to services, instead of production.

The monetary policy committee examines not only exporters, but also importers and customers. “The macroeconomic picture of an economy that emerged from crisis is positive.”

Unannounced intervention — which have occurred a lot recently, traders say — can prevent excessive strength episodes while allowing gradual gains. Goldman Sachs (NYSE;) predicted “continued and gradual shekel appreciation”. The forecasters predicted a 3.05 percent rate within six months.

Israel’s exports of high-value technology, accounting for 14% percent of its GDP, are fairly well protected from fluctuations in exchange rates. But Yaron’s remarks and actions do not sit well with other exporters.

Israel Chemicals, for example, stated that currency weakness had reduced operating profits by $17million in the third quarter compared to a year ago.

Ron Tomer from Israel’s Manufacturers’ Association said that about a third have moved production to overseas. “And it keeps on growing.”

Tomer stated that “until the most recent shekel movement, a lot companies were selling at loss or cost.” “Now, with the shekel at 3.10… people are no longer able to dip into pocket cash.”

He asked policymakers for continued interventions, and urged the government to intervene, saying that “when you see the shekel strengthening by 3% per day, it’s impossible to sustain any plan.”