Bank of Israel keeps rates unchanged, shekel up over 8.5% against dollar this month 

The Israeli shekel has been a top performer in foreign currency markets this month, surging close to 8.5% against the dollar from its late-October low.

Currently trading at 3.67 per dollar, the shekel managed to recover from earlier losses incurred during the sudden outbreak of the Israel-Hamas war in early October. The conflict initially led the currency to an 11-year low before its fortunes reversed. 

The Bank of Israel played a key role in this rebound, intervening as the shekel declined approximately 6% in the weeks following the October 7th attack by Hamas. To defend the shekel, the central bank proved willing to shrink its reserves, which fell by $7.3 billion last month. Other efforts to boost liquidity included the provision of $15 billion through swap lines.

A shift in investor sentiment has also contributed to the shekel's recovery. Initial concerns about the conflict spreading regionally led to a surge in shekel shorts in October, reaching their highest level in two years. However, despite early apprehensions, the war in Gaza has largely remained contained, leading to a temporary ceasefire.

During the shekel's decline, there were concerns that the Bank of Israel might be compelled to raise interest rates to support the economy during wartime. However, with the currency's regained strength, the central bank maintained its interest rates, keeping them steady at the 4.75% level on Monday.

Bank of Israel: BoI keeps rates steady at 4.75%, outlines economic effect of war

On November 27, Israel's central bank laid out its most comprehensive assessment of the economic implications of the conflict with Hamas to date, as it continued to hold off interest rate cuts in favor of stabilizing markets. The Bank of Israel's research department estimated the "gross effect" of the war on Israel at 198 billion shekels ($53 billion), with defense spending making up more than half of the total. Earlier estimates from Leader Capital Markets projected a fiscal cost of 180 billion shekels in 2023-2024, while the Finance Ministry indicated a daily economic impact of close to $270 million.

Along with the updated outlook, the Bank of Israel's research team revised its economic growth projections, anticipating a 2% expansion in gross domestic product (GDP) for both this year and the next. This marks a decrease from previous estimates of 2.3% in 2023 and 2.8% in 2024. The Finance Ministry shares a similar GDP forecast for this year but envisions slightly weaker gains ahead.

On Monday, the monetary committee maintained the key interest rate at 4.75%, aligning with expectations. Following the announcement, the shekel strengthened against the dollar.

Speaking after the decision, Governor Amir Yaron warned “the fiscal ramifications” of the war will endure over the medium term and urged caution from the government as it hammers out a new budget. He added: 

“Alongside the need to provide a budgetary response to needs created by the war, in emergency times as well there is considerable importance to maintaining a responsible fiscal framework. t is important that the government cut new expenditures of a prolonged nature.”

Shekel forecast: USD to ILS rate could depend on central bank decisions, inflation

As economic damage from the war spreads, the possibility of a rate cut has resurfaced, given the Israeli shekel's nearly 9% rise against the dollar since the Bank of Israel's last meeting on October 23. 

This week's decision was the first since Amir Yaron's reappointment as BoI governor for another five-year term. Throughout his tenure, Yaron has only cut rates once, during the peak of the Covid-19 pandemic in 2020. He then oversaw a record-long period of monetary tightening, pushing borrowing costs to their highest level in 17 years.

While the risk of inflation may currently impede future rate cuts, with price growth exceeding the government's target range of 1% to 3% since late 2021, the central bank said on Monday that “in view of the recent volatility of the exchange rate, depreciation of the shekel continues to pose a risk to the convergence of inflation to the target range.”

Although the outlook remains uncertain, Israel has defied some earlier predictions of a significant price surge, as annual inflation slightly slowed to 3.7% in October.

Ori Greenfeld, chief strategist at Psagot Investment House, told Bloomberg: 

“This may be an inflection point for inflation, because in the long run, transport difficulties, shortage of raw materials and pressure on the housing market can push prices up. The central bank may choose to wait until there is more certainty that inflation will inch down to its target range of 1%-3% before it cuts rates.”

The USD to ILS exchange rate stood at 3.6746 at the time of writing, with the shekel up 0.18% on the day against the greenback, as per MarketWatch data. The dollar to shekel rate has fallen by close to 8.5% over the past month as of November 29.

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