World-Beating Currency Leaves Israel Economy Struggling to Grow

Shekel rises beats most major peers vs dollar, euro in 2015
Traders losing faith in central bank’s ability to curb gains

By Sharon Wrobel, BLOOMBERG

Israel is running out of ways to free itself from the burden of a world-beating currency.

The shekel is one of just three major peers to avoid being crushed by the dollar’s advance this year and is the second-best performer against the euro with a jump of 11 percent. Traders see little chance of the gains evaporating, with options signaling about 70 percent odds the currency will revisit its 2015 highs by next December.

While the shekel is supported by profits from Israel’s 2009

natural-gas discovery, its strength is holding back the rest of the economy, which derives a third of its earnings from exports and which strategists estimate is growing at the slowest pace in six years. The Bank of Israel has already cut interest rates to near zero to curb the currency’s gains, leaving Governor Karnit Flug limited room to maneuver. The other side of the exchange rate may also be under pressure since the U.S. Federal Reserve committed itself to only gradual increases in borrowing costs last week.

“I don’t see the shekel weakening even as the Fed raises rates as the fundamentals in Israel’s economy continue to support a strong currency,” said David Reznik, a Tel Aviv-based strategist at Bank Leumi Le-Israel Ltd., the nation’s second-biggest lender. “Flug is concerned about the strength of the currency, but there’s not much left for her to do other than leaving interest rates low for the coming year and buying dollars from time to time.”

Sole Gainers

The shekel is the only one of 31 major currencies tracked by Bloomberg to have beaten the greenback this year, apart from the Swiss franc and the Hong Kong dollar, which is pegged to its U.S. counterpart. Israel’s currency has climbed 0.1 percent in 2015. Four straight years of gains versus the euro may be of more concern to policy makers, though, because Europe is Israel’s biggest trading partner.

There’s a 68 percent chance the shekel will match this year’s high of 3.7450 per dollar, reached in June, by the end of 2016, options data compiled by Bloomberg show. The odds of a return to 4.0851 per euro, the 13-year high achieved last month, are 73 percent. Both would represent gains of more than 3 percent from Friday’s levels of about 3.89 per dollar and 4.22 to the euro.

Flug has said the shekel is overvalued. Still, none of the 17 economists surveyed by Bloomberg expect the BOI to cut its main interest rate from a record-low 0.1 percent at its meeting on Dec. 28.

Exceptional Measures

“The question is how long can they wait before action is taken,” said Piotr Chwiejczak, a London-based analyst at BNP Paribas SA, the second most-accurate shekel forecaster in Bloomberg’s third-quarter rankings. “The central bank has indicated that it will avoid non-standard measures at all costs to try and weaken the shekel, and I don’t understand why,” he said.

BNP Paribas sees the shekel remaining little changed at about 3.8 per dollar through the first half of 2016. While the median mid-year estimate in a Bloomberg survey is for a decline to 3.93, strategists have raised that forecast from 4.03 at the start of this month.

The BOI said in November it plans to purchase $1.8 billion in foreign-exchange markets in 2016 to offset the effect of gas production on the nation’s balance of payments. That’s less than the $3.1 billion it planned to buy this year. Gas production has helped push Israel’s current-account surplus to the widest since the first quarter of 2014, supporting the shekel at the expense of growth.

Israel’s $306 billion economy will expand 2.5 percent in 2015, according to analysts surveyed by Bloomberg, the slowest pace since 2009. The strong shekel is also holding back prices of consumer goods, with the nation suffering more than a year of negative inflation.

The BOI will be forced to act if the currency gets much stronger, according to Jerry Cutiesteanu, senior investment manager at Tel Aviv-based Israel Brokerage & Investments Ltd., where he oversees 18 billion shekels ($4.6 billion) of assets.

“We expect the shekel to continue to be strong in 2016 as the factors that are driving the currency’s strength will remain intact,” said Cutiesteanu. “The central bank will do everything they can to weaken the shekel and in case of a sharp appreciation we also see room for Flug to cut interest rates to negative territory.”