Deutsche Bank predicts that the "shekel rally has finally come to an end", after the Bank of Israel announced the four-fold increase in its daily dollar buying program to $100 million in an attempt to halt further shekel appreciation.
Deutsche Bank notes that, "As the total amount of dollar buying has been left unchanged at around $10 billion, this should mean the program is finished by year end. In the face of an expected annual reserves build-up of $12.5 billion for 2008 it seems the shekel rally has finally come to an end."
Deutsche Bank warns, however, "But while a weaker exchange rate will take some pressure off nominal competitiveness concerns it should also push inflation higher and therefore neutralize any impact on the real exchange rate. The Bank of Israel has noted on several occasions during recent months the declining pass-through from foreign exchange to inflation. A large chunk of this is due to a drop in the proportion of rental properties priced in dollars. And while the Bank of Israel may be comfortable that pass-through has declined, that is not to say that it has disappeared altogether."
Deutsche Bank also points out that the "fairly aggressive move to push the currency weaker also sits awkwardly with the Bank of Israel’s ability to meet its inflation target." It notes that the Consumer Price Index (CPI) was at 5.2% year-on-year as of May, well above the 1-3% target. While CPI has been both above and below target in the past, it is unusual for inflation expectations to move significantly away from the midpoint of the range. Recent months has seen inflation expectations come out above the top of the band at 3.3% and the announcement could well push this higher.
Deutsche Bank also noted the shekel sell-off that following Thursday's announcement, which pushed the shekel-dollar exchange rate down 4.5% to nearly NIS 3.37/$, because $100 million purchases "is a large ticket for Israel where total daily turnover is around $2 billion". However, the effect on the shekel through the rest of the year largely depends on how long the Bank of Israel maintains the new pace of accumulation. "In the three full months since the reserves program has been in place the Bank of Israel bought a total of $1.25 billion. At the higher pace, the Bank of Israel should accumulate approximately $9.7 billion by year end. This would therefore bring reserves to $41 billion (foreign currency reserves stood at $31.3 billion at end June). Barring any changes to reduce the pace of reserves build-up, this should mean that the program ends in 2008."
Deutsche Bank concludes, "Barring any significant capital inflows it is likely that the shekel rally has therefore finally come to an end."
Published by Globes [online], Israel business news - www.globes-online.com - on July 13, 2008
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