Why is the shekel so strong?

• Author: Guy Ben Simon
• Published date: 31 October 2021
• Publication title: Globes (Rishon LeZion, Israel)

Apart from the positive state of the Israeli economy, there are several factors that account for the appreciation of the shekel in recent years, some of which have become even stronger recently, as the economy emerges from the fourth wave of the Covid-19 pandemic and aid programs designed to support the economy during the pandemic become unnecessary and are set to expire.

1. Greater expectations of an interest rate hike

Although the Bank of Israel expects that in a year's time its key lending rate will be in the range of 0.1-0.25%, higher than the current rate of 0.1% but low from a historical perspective, the local bond market is pricing in expectations of higher rates, which tends to strengthen the shekel in anticipation of higher inward movements of capital.

In setting its interest rate, the Bank of Israel examines the effective exchange rate, that is, the rate against a basket of the currencies of Israel's main trading partners. The effective rate is at an all-time low, meaning that the shekel is stronger than it has ever been against Israel's trading partners' currencies. The stronger the shekel becomes against the basket of currencies, the lower the shekel amount that exporters receive for their products, so that, if the Bank of Israel wants to continue to protect exporters, the shekel's current level is a warning sign.

On the other hand, the Bank of Israel is under no pressure to raise interest rates. Unlike central banks in other countries, that have raised their rates in order to curb sharply rising inflation, the Bank of Israel has more room for maneuver before raising its rate, since inflation in Israel is lower, mainly because the strong shekel makes imported goods cheaper. Besides, the source of the current price inflation lies in supply problems rather than in demand, which means that a rise in interest rates at this point would be liable to choke economic activity and result in unemployment. And what of the exporters? So far this year, exports have only risen, despite the shekel's strength.

2. Massive inward investment

Hardly a week goes by without the report of an exit by an Israeli technology company in the tens if not hundreds of millions of dollars. The movement of capital into Israel as a result of acquisitions of companies, mainly in the technology sector, entails a rise in demand for shekels, since the dollars coming to Israel need to be converted to local currency. Last year, direct inward investment in the Israeli economy totaled...