Potential escalation in the north of Israel weighs on shekel

Shekel pressured due to potential military escalation at border with Lebanon

The Israeli shekel (NIS) has appreciated against a range of major currencies this week, with the USD to ILS exchange rate gaining 1.84% to trade at 3.7456, while the euro to shekel rate is up by 2.2% at 4.118.

The British pound to shekel rate has followed a similar trajectory, with GBP/ILS gaining 2.28% over the past 5 days to trade at 4.7831 at the time of writing on Friday.

The substantial losses for the shekel appear to be primarily linked to the security escalation in Israel, while the U.S. dollar has remained largely steady against other foreign currencies in recent days. The DXY index — a measure of the greenback’s performance against a basket of major peers — has shed 0.1% since Monday.

In a comment to Israeli financial publication Globes on Wednesday, Israel Discount Bank macroeconomic and markets analyst Einat Meir said:

"At the start of the month, the weakening of the shekel was supported by negative sentiment in the stock markets abroad, and in particular, by sharp declines on Nasdaq. However, in recent days the shekel's depreciation has strengthened due to the worsening security situation in the north, a deterioration, which has also been reflected in the increase in Israel's CDS premium, despite the renewed gains on Nasdaq."

"The growing fears of a real escalation on the northern front, in view of another assassination of a Hezbollah operative, is weighing on the shekel”, added Mizrahi Tefahot Bank chief economist Ronen Menachem.

Menachem stressed that as the retaliatory attacks persist, the assumption that the conflict on this front will not escalate into a full-blown war are being progressively eroded, along with all their potential repercussions. Tensions in the Middle East are high, with British and U.S. forces recently launching airstrikes on Houthi rebel targets in Yemen, escalating a conflict with an Iranian proxy in response to a string of attacks that have disrupted commercial shipping in the Red Sea. Iran, which backs the Houthis, sent a warship into the Red Sea at the start of the year.

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Shekel risks: Political developments also weigh on the Israeli currency

Tensions are heating up on Israel's political front as well. Senior army generals and government figures have made statements suggesting that the war will continue throughout 2024, according to Menachem.

"There is [also] the tension around the 2024 state budget, which should be discussed in the cabinet and the Knesset for approval by the end of the month. Reports in the media about disputes between senior Ministry of Finance officials obviously does not add to the health of the situation. Then there is the difficulty of financing the growing deficit within the current coalition limitations”.

Einat Meir pointed out to Globes that the Bank of Israel (BoI) refrained from selling any dollars during December 2023. Since October, it has only sold $8.5 billion out of its planned $30 billion of forex reserves, as announced following the war's outbreak.

The shekel was notably the world’s top-performing currency in November last year, after support from the Israeli central bank propelled it to recover to pre-war levels. The conflict initially led the currency to an 11-year low before its fortunes reversed on the back of foreign exchange sales and the provision of $15 billion through swap lines by the BoI.

Israeli shekel forecast: Volatility to continue and NIS may appreciate, say analysts

Meir said that the Israel Discount Bank sees volatility in the shekel continuing in the near future due to the effect of the war:

"The continued weakening of the shekel may lead the Bank of Israel to resume its foreign currency sales. In our estimation, the volatility in the foreign exchange market will continue due to the uncertainties arising from the consequences of the war".

A shekel forecast by Ronen Menachem said the shekel may slide further:

"There is a momentum that may constitute a correction to the sharp appreciation of NIS 0.45 since the depreciation that came at the beginning of the war”.

Despite the risks and volatility outlined by both Meir and Menachem, multiple analysts have pointed to the overall resilience and strength of the Israeli economy.

In a January 4 piece for The Jewish Chronicle, journalist Alex Brummer cited Goldman Sachs analysts as saying Israel was less economically vulnerable today than in previous episodes of conflict:

“After an initial currency collapse at the start of the conflagration, the shekel has bounced back strongly. It is now worth three per cent more against the dollar than on October 7. [...] There will be severe economic costs for Israeli citizens and taxes may eventually have to rise to pay for the war. The Knesset finance committee favours one-offs, such as a windfall levy on the banks, rather than a hike in income taxes. But as investment bankers Goldman Sachs note: ‘Israel’s economic and financial vulnerabilities are much lower today than compared to other major episodes of escalating violence.’

The country is protected by its strong currency reserves, reduced dependence on inflows of foreign currency and robust underlying growth. The rebound in the value of the shekel means that when the conflict eases the Bank of Israel has scope to reduce interest rates.

Past prudence in managing Israel’s economy mean that stability is not threatened. A rapid recovery of lost wartime output — once the guns are silenced — is eminently possible”.

The USD to ILS rate was 3.7457 at the time of writing on Friday, with the greenback gaining close to 4% on the shekel year-to-date. EUR/ILS traded at 4.1143 (+3.46% year-to-date).

The British pound to shekel rate stood at 4.7855, with sterling gaining 4.32% on the Israeli currency since the start of the year.

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