Israel's strong macroeconomic data and structural shifts in the balance of payments are the main parameters driving the shekel's continued sharp advance, moreso than the weakness of the US dollar around the world, Morgan Stanley argued Monday.
"Even though the dollar's weakness has certainly played a role in the shekel's recent appreciation, Israel's own macroeconomic and structural features are more important in determining the value of its currency," Serhan Cevik, an analyst at Morgan Stanley noted in a report to clients titled "Israel: When Everybody Loves the Shekel."
"The Israeli economy has enjoyed a marked acceleration in real GDP growth and shifts in the current account balance from an average deficit of 2 percent of GDP a year in the 1990s into an average surplus of 3% of GDP in the past four years and as much as 5% of GDP in 2006," he said.
The shekel has gained 6% on the dollar since early November and stood at 4.067 on the eve of Independence Day. Amid the shekel's sharp advance in recent months and demands that interest rates be lowered further, Bank of Israel Governor Stanley Fischer has reiterated his often-stated belief that the currency really was exhibiting strength only against the dollar, which is experiencing a global slump, and that when compared with the currency basket and Europe it was stable.
Cevik added that although in the US investment bank's view the shekel still remained undervalued. The recent move of the shekel below 4.10 against the dollar had been much faster than the bank's out-of-consensus expectation and created a policy dilemma for the central bank.
This week, the Bank of Israel lowered its benchmark lending rate by a quarter-point to 3.75% and signaled further cuts following five earlier reductions that failed to halt the appreciation of the shekel against the dollar and boost inflation to the government's target range of between 1% and 3%.
Following the central bank's interest rate decision, analysts were not expecting an imminent reverse trend in the shekel-dollar exchange rate.
"Interest rate cuts are not bringing an immediate correction," said Cevik. "This policy approach may not necessarily be effective in the short-run, since the shekel's appreciation is a result of fundamental improvements and structural changes in the economy. In other words, the economy has experienced a structural shift in the current account, while the composition of capital flows is not very sensitive to interest rates."
As such Morgan Stanley warned that aggressive monetary easing, instead of bringing stability, could lead to asset price bubbles and higher volatility in the exchange rate and inflation in the future.