'Surging shekel puts pressure on Fischer'

With the shekel at 6-year high central bank will need to rethink policy, analysts say.

The shekel continued to strengthen against the dollar on Thursday, trading at a near six-year high, heightening market speculation that the Bank of Israel might be forced to cut interest rates by as much as half a percentage point when it sets rates for May. "Strong macroeconomic data, strong inflow of foreign investors buying shekels and a rallying stock market have all contributed to the gaining of the shekel," said Ayal El-Peleg, vice-president of investments at Gaon Investment House. "To slightly weaken or stabilize the local currency, the Bank of Israel might be forced to cut interest rates sharply, rather than hold interest rates and there is speculation in the market that it might cut as much as 0.5 of a percentage point at the end of the month." The shekel rose sharply against the dollar on both Wednesday and Thursday amid signs that the central bank will keep interest rates on hold in coming months and as rising stock markets lured investors to emerging-market assets, such as Tel Aviv. The shekel gained another 0.15% against the US dollar on Thursday closing at NIS 4.129, its highest level since June 2001. "Since the Bank of Israel's latest decision to leave the interest rate unchanged at 4% in April, and in light of a weaker dollar in international markets, the shekel has gained another 1.7% against the greenback," said analysts at Excellence Nessuah. "Given the low level of inflation, last year's missed inflation target and the significance of the dollar on inflation, a further cut is looking likely." To weaken the shekel, the Bank of Israel has cut interest rates by 150 basis points since October to 4%. The central bank would like to see the shekel weaken against the dollar as a low dollar keeps inflation below the government's 1% to 3% target range for inflation. Last year, the central bank missed that target widely, when inflation ran at minus 0.1%. Despite the interest rate cuts in the months before April, the shekel has continued to strengthen gradually as foreign investors keep buying the currency to make investments in Israel and the market has remained unfazed by the central bank's monetary policy. "The central bank's monetary policy to cut interest rates by 25 basis points to weaken the strength of the local currency and raise inflation back into the target range did not the bear the desired fruits as the market and the macroeconomic data were stronger," said El-Peleg. "Thus cutting interest rates by 25 basis points by the end of the month is not likely to have much of an impact on the market." Similarly, economists at Leader Capital Markets forecast that the central bank will need to cut the base lending rate by a minimum of a quarter-point. "Still, the difference between 4% and 3.75% will not be that significant," Leader said. "In the short-term, we expect the shekel to trade between NIS 4 and NIS 4.20 per dollar, but if the central bank decides to halt interest rates again, the shekel could gain further and trade below NIS 4." On the other hand, Serhan Cevik, an economist at Morgan Stanley, noted in a report to clients that the central bank's decision to keep interest rates unchanged would support stability. "The Bank of Israel's decision to keep interest rates unchanged will support stability. Clearly the economy is on an above-trend growth path, and that justifies no further monetary easing even though we still expect the shekel to remain strong," said Cevik. "The country's improving net international position supports the shekel's valuation and could indeed help to keep the Israeli economy in a sweet spot."