Israeli Shekel’s drop against the Dollar likely to continue. Here’s why
Three things that happened Monday evening sent the shekel down on Tuesday against the U.S. dollar to an exchange rate of 3.64 shekels per USD.
The Bank of Israel’s decision to raise interest rates by 0.5 percentage points, marking the eighth consecutive hike since April; Foreign Minister Eli Cohen’s bizarre tweet urging Finance Minister Bezalel Smotrich “to draft a plan with the Bank of Israel governor to stop the rise in interest rates,” on the grounds that there was no justification for them; and above all, the fact that the first two bills in the government’s plan to weaken the legal system passed their first Knesset votes.
Usually, when Israeli interest rates rise, the shekel grows stronger, because it becomes more worthwhile to invest in shekels and thereby benefit from the high interest rates. But this time, the opposite happened, because the other two events carried greater weight.
The interest rate increases over the past several months are meant to rein in the high inflation (5.4 percent over the last 12 months) that began due to the war in Ukraine, which led to higher prices for oil and many other products. Together with the supply problems caused by the coronavirus crisis, this war sparked inflation worldwide. The Bank of Israel has been trying to catch up to inflation, but keeps being surprised by the fact that inflation keeps accelerating and refuses to be restrained.
Until recently, it was possible to blame the inflation problem on the world – Russian President Vladimir Putin, China, the global supply chain. But now, some of it stems from developments here at home.
One of the new factors spurring inflation is the dollar’s growing strength against the shekel. Since August 2022, it has gained 10 percent, and on Tuesday, it rose by another 2.4 percent, closing at almost 4.65 shekels.
- Israel’s judicial overhaul is setting back the property market
- Bank of Israel raises interest rates for 8th consecutive time
- Inflation hits highest rate since 2008; interest rate hike expected
The dollar rises when investors sell shekels and buy some other currency – dollars, euros or pounds sterling, all of which gained sharply against the shekel on Tuesday. The sellers include high-tech companies, mutual funds and other businesses worried by recent developments in Israel’s economy.
On one hand, the economy is strong and growing. But on the other, the positive sentiment that buoyed it in recent years, which was due to the flourishing high-tech industry, has started to wane due to the plan to weaken the legal system.
This is happening against the backdrop of warnings and petitions from hundreds of well-known economists both in Israel and abroad, as well as high-tech entrepreneurs, businesspeople and banks. All are warning about the legal overhaul’s effects on Israel’s credit rating and the harm a weaker legal system could cause to business interests.
The stronger dollar is good news for exporters (high-tech accounts for 56 percent of all Israeli exports). But it’s not good news for local consumers, because it raises the price of imported products – cars, appliances, cellphones, certain food products and more. This has further increased inflation, and will therefore lead to more interest rate hikes in the future.
Higher interest rates are intended to cool demand, which leads to higher prices. But it has a direct impact on anyone with a mortgage, because mortgage holders now face higher monthly payments. Since the interest rate hikes began in April 2022, the average monthly payment has soared by over 1,000 shekels ($275).
Inflationary pressures are likely to intensify soon, when a new public-sector wage agreement is signed that grants raises to hundreds of thousands of workers. The raises are meant to compensate them for the erosion of their salaries over the last three years due to the combination of a salary freeze and inflation.
In its announcement of the interest rate hike on Monday, the Bank of Israel noted that its ability to reduce inflation will be affected by both the public-sector wage agreement and the extent of the increase in the state budget for 2023, which the cabinet is now working on approving.
The 2023 budget is slated to be tens of billions of shekels higher than the 2022 budget. This increase will include billions of shekels in specific allocations demanded by the governing coalition’s member parties, and these allocations are not considered engines of growth.
The shekel’s decline against other foreign currencies may well continue in the coming weeks, depending on the speed with which the legislation to weaken the legal system advances, and especially if no compromise is reached that would minimize harm to the legal system. In that case, credit rating companies may well warn that they are likely to lower Israel’s credit rating in the future, and then the flight of capital from Israel would accelerate.