Weakening shekel could mean sharper rate hike

Next week the Bank of Israel Monetary Committee will meet to discuss the interest rate decision. The expectation was that it would hike the interest rate by another 0.25% and it is still quite likely that this is what will happen. But over the past week there has been a trend that might persuade the Bank of Israel to raise the rate by more than planned: the shekel has been weakening against the dollar.

The depreciation of the shekel against the dollar contributes to inflation by pushing up the prices of imported goods and commodities, and a rise in inflation could lead to the Bank of Israel tightening monetary policy. In other words raising the interest rate by more than planned, perhaps by 0.5% instead of 0.25%. Such a development would be felt in even higher monthly mortgage repayments, at least for some homeowners who have taken loans.

Weakening against expectations

Expectations of this kind can be found in the analyst reviews published today. For example, Leader Capital Markets chief economist Yonatan Katz says, “The depreciation of the shekel continues due to political uncertainty and fear of capital outflows. This trend, if it continues in the coming week, could support an interest rate hike of 0.5%” – with the caveat that things depend on the January Consumer Price Index, which will be published on Wednesday this week.”

Although Bank Hapoalim chief strategist Modi Shafrir believes that the interest rate will rise by 0.25%, he adds that in his estimation the Bank of Israel, “Will give relatively great weight in the upcoming decision to developments on the foreign currency market, so that the more the shekel continues to weaken towards NIS 3.65/$, the stronger likelihood of a 0.5% hike.”

Shafrir recalls that in last month’s Bank of Israel interest rate decision, in which the rate was hiked by 0.5%, one member of the Monetary Committee supported a 0.75% hike, “due to the rise in inflation and the ongoing depreciation in recent months.”

Meitav Dash chief economist Alex Zabezhinsky chose to focus on another development. The change in the link between the shekel-dollar exchange rate and the behavior of the US stock market. In recent years, the rise on Wall Street was translated into the strengthening of the shekel because of hedging deals by Israeli institutions. But in recent weeks this pattern should have brought about the strengthening of the shekel but the exact opposite has happened.

Due to this change Zabezhinsky stresses, there will be a range of repercussions. A weaker shekel means higher inflation. Ultimately he says, “The strength of the shekel made various investment options attractive in Israel for foreign investors.” It can be assumed that if the shekel weakens, then the attractiveness of these investments will be reduced.

Psagot chief economic Ori Greenfeld urges that matters are not blown out of proportion. “While the strengthening of the dollar has attracted major media attention, the exchange rate has only returned to its level at the start of the year.” But he agrees that the shekel-dollar exchange rate supports rising inflation and a higher interest rate, although stressing that there are factors pushing in the opposite direction such as the rise in bond yields on the markets.

One of the criticisms of the Bank of Israel has been that it has followed in the wake of the US Federal Reserve – the US central banks raises rates and the Bank of Israel follows suit. But even a decision to follow the Fed is a decision. After all, the Bank of Israel could also raise interest rates faster, or more slowly, than in the US. However, the weakening of the shekel due to the judicial reforms promoted by the Netanyahu government and the uncertainty that comes with it – may change the situation, forcing the Bank of Israel to rethink its course.

Published by Globes, Israel business news – en.globes.co.il – on February 12, 2023.

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