Israel's Central Bank purchases Dollars to keep Shekel down

[MikeWB]

Israel's Central Bank purchases Dollars to keep Shekel down

Dollar purchase by Israel's central bank temporary fix

by Zhang Yanyang and Xu Gang

http://news.xinhuanet.com/english/2009- ... 843707.htm

JERUSALEM, Aug. 7 (Xinhua) -- Stanley Fischer, governor of Bank of Israel, Israel's central bank, caught the foreign currency market off guard this week when he bought several billion U.S. dollars over the course of several days in a surprise move that sent the dollar to shekel exchange rate up more than 5 percent from an eight-month low.

Fischer on Monday afternoon said the bank would intervene in the event of unusual movements in the exchange rate that are inconsistent with underlying economic conditions, or when conditions in the foreign exchange market are disorderly, making it clear the central bank will enter the market whenever it perceives the need.

The dollar to shekel exchange rate was set at 3.931 shekels to the dollar on Thursday. Since December 2008, the rate had seen a steady rise to well over 4 shekels to the dollar nurtured by dollar purchases Fischer initiated in March 2008 in an attempt to curb the shekel's rally.

The shekel had appreciated to a 13-year high against the dollar when it reached 3.23 shekels to the dollar on July 9, 2008.

The more expensive shekel weighed on Israeli producers leading to a 40 percent drop in exports in 2008, and was one of the main reasons why Fischer decided to intervene in the foreign currency market by buying 100 million U.S. dollars on regular trading days and 50 million U.S. dollars on Fridays.

However, the dollar purchases, which had the declared goal of increasing foreign currency reserves to the accepted level in developed countries of about 44 billion U.S. dollars, over time became priced into the market as speculators knew exactly how much and when the central bank would buy dollars, thus becoming less effective as a tool to curb the shekel's rise.

"The dollar purchases made an important difference as they raised the dollar to shekel rate 5 percent," Zahi Elias, head of forex trading at Bank Leumi told Xinhua in a telephone interview.

Elias said it was clear the central bank's policy of transparency had become ineffective. The Bank of Israel's surprise move was in line with other central banks, and its change in tactics was necessary to indicate its disapproval with the soaring shekel.

He noted that the central bank had demonstrated its power in controlling the market and keeping dollar selling low.

Nevertheless, it is clear that the central bank would not be able to pursue dollar purchases endlessly. Foreign currency reserves had long surpassed the targeted 44-billion-USD objective and already exceeded 50 billion.

"In the long run dollar purchases will not be effective," Elias said, noting that Fischer was happy with the rise he had managed to inspire as the dollar purchases had offered the desired effect, but future moves in the market strongly depended on the trends in the world market and if the dollar drops globally, it would also do so in Israel.

"As Fischer himself said, Israeli exporters can take advantage of the break which afforded them through the dollar purchases for now, but in the long run they will have to establish their own protective barrier," Elias said.

Ayelet Nir, chief economist at IBI Investment House in Tel Avivechoed Elias' views that Fischer's intervention through dollar purchases was wise and said it should have been done a long time ago.

"Pressure for the appreciation of the shekel was there all the time and increased once the Bank said they would stop buying dollars, causing the market to price in a rise in the shekel," Nir told Xinhua.

"Fischer understood that it was speculative pressure that pushed up the shekel, so he started buying dollars but without telling the market how much he would be buying and when, thus making it harder for speculators to guess the direction of the dollar to shekel rate," she said.

She noted that Fischer would continue to intervene as long as he feels that his actions will help the exporters, saying that "Once he sees that exports have sufficiently risen to prod up the shekel themselves he will move out of the market."

Analysts noted that there were various strategies for the central bank to lower its intervention over time.

The bank would first have to lower its daily purchase volume and see how the market reacts. In the event the dollar stays stable, purchase volume could gradually be lowered to zero. If that proved ineffective, the bank could pursue an unpredictable buying pattern much like Fischer has already started.

Ultimately, however, the easiest way for the central bank to withdraw from the foreign currency market would be once the U.S. dollar's status improves around the world, or Israeli exports increase, both of which would boost the dollar to shekel exchange rate.

Analysts said the large foreign currency reserves Israel had amassed did not pose a problem. The money could be deposited in commercial banks, to keep the money supply in circulation from growing and thereby curb inflationary pressure.

"Large reserves are a sign of a country's economic strength, and it is not a bad thing for Israel to have large foreign currency reserves," said Elias.