fifty shekels 88.
(photo credit: )
Interest rate cuts by the Bank of Israel failed to curb the rally of the shekel, which rose to a seven-year high against the dollar on Thursday and flirted with the psychological barrier of four shekels per dollar, leaving analysts divided over where the local currency will go from here.
"The shekel-dollar exchange rate might fall below the psychologically significant level of 4 as long as the dollar is seen to be weakening in global markets," said Yair Alek, CEO of Axioma Investment House. "In the short-term, we are likely to see the shekel gaining as the dollar is expected to weaken further on the back of current US economic data showing a slowdown in the US economy."
The shekel strengthened to as much as 4.0013 against the dollar on Thursday morning, the highest since 2000 but retreated to 4.02 by the end of the day,
In a recent report, Morgan Stanley argued that Israel's strong macroeconomic data and structural shifts in the balance of payments had been the main parameters driving the shekel's continued sharp advance, more so than the dollar weakness around the world.
Similarly, the Bank of Israel has been stressing that the current account surplus widening to $6.8 billion and foreign investment reaching a record of $21.2b. have been supporting the shekel in recent months. Since October last year, the Bank of Israel has been cutting interest rates, but the cuts have not succeeded in weakening the currency.
"Although the central bank has continued to cut interest rates over recent months, the rate cuts should have been faster to bring inflation back into the target range," said Shlomo Maoz, chief economist at Excellence Nessuah. "Israeli interest rates should be as low as 1.75% or maybe 2%."
The central bank would like to see the shekel weaker against the dollar, as a low dollar keeps inflation under the government's target range, which is between 1% to 3%. Last year, the central bank missed that target widely, when inflation ran at minus 0.1% and this year the central bank was planning to bring inflation back into the price target range by last quarter.
On Sunday, the central bank lowered the May base lending rate by 25 basis points to 3.75%, widening the interest rate gap with the US an unprecedented 1.5 percentage points.
"Looking ahead, there will be pressure on the Bank of Israel to make further moderate interest rate cuts over the next few months," said Alek. "The widening gap between the local interest rate and US interest rate will in the long-term lead to a correction of the shekel."
Similarly, Dr. Michael Sarel, head of the economics and research division at Harel Insurance Investments, said that although the rally of the shekel was not at its peak yet, the widening interest rate gap between Israel and the US was likely to reverse the appreciation track of the local currency in the long-term.
"A wider par between local and US interest rates will make investment into foreign markets more attractive and increase the probability of reversing the direction of the shekel," said Sarel.
On the other hand, Bank Leumi economists were wary of the inflationary impact of any further interest rate cuts.
"As the recent interest rate cuts have not had the desired effect of weakening the shekel to raise prices and bring inflation back into the price target range, we are wary that any further moves in addition to the recent cuts will cause higher volatility in the inflation rate shooting beyond the target range in 2008 and 2009," Bank Leumi economists said in a note to clients.
Furthermore, Alek at Axioma and Sarel at Harel cautioned that aggressive monetary easing could boost capital market activity leading to share price bubbles.
Still, Excellence Nessuah's Maoz argued that aggressive monetary easing and direct interference of the Bank of Israel into the forex market were the only remedy to ease the shekel and bring inflation back into the target range.
"There are a few countries that have taken the step of intervening in trading in the past few years such as South Korea and Singapore to rescue their economies," said Maoz. "The central bank could buy up dollars to increase foreign currency reserves or it could issue bonds that would curb the demand for shekels."
Earlier this month, however, Bank of Israel Governor Stanley Fischer said he had no intention of intervening in the foreign exchange markets to influence the shekel.
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