Bulls Unbowed as Flug's $1.4 Billion Spree Fails to Stem Shekel

(Bloomberg) -- Israel's central bank is fighting a losing battle against the surging shekel.

The currency strengthened 3.5 percent against the dollar in February, trailing only Mexico's peso among 31 major peers and rising to its strongest level since September 2014, even as policy makers bought some $1.365 billion of foreign currency, the most since December 2015. Despite the Bank of Israel's efforts, options traders are the least bearish on the shekel in almost eight years.

With borrowing costs at a record low since 2015 and the dollar purchases having little impact, central bank Governor Karnit Flug is running out of options. A strong shekel may threaten the competitiveness of Israel's exports, which account for about a third of gross domestic product.

“As long as the central bank's only tool to combat the strong currency is to buy dollars from time to time, its effectiveness to reverse the trend will be limited,” said David Reznik, a Tel Aviv-based strategist at Bank Leumi Le-Israel Ltd., the nation's second-biggest lender. “In the long term, a strong shekel is worrisome for Israeli companies as it damages production and could hurt employment.”

There's nothing to stop the shekel from rallying in the coming months to 3.5 a dollar, 5 percent stronger than Tuesday's close, according to Reznik. The currency has fallen 1.2 percent in March and was trading down 0.3 percent at 3.6854 as of 2:54 p.m. in Tel Aviv on Wednesday.

Underpinning the shekel's strength is an economy that expanded 6.2 percent in the fourth quarter, the fastest pace since 2013, as exports surged. That outperformance may be setting the stage for a reversal, with industrial production falling 0.5 percent in December from the previous month.

Finance Minister Moshe Kahlon raised concerns about the shekel's strength in an emergency meeting with manufacturers on Monday. Policies are needed to support the industry and boost productivity, alongside the Bank of Israel's short-term monetary actions, he said.

Israeli debt is very close to being added to the World Government Bond Index, Luis Costa, a strategist at Citigroup Inc. in London, wrote in a note on Monday. While that would be positive, the finance ministry is “ambivalent” about the move because of the extra inflows it might bring, he said.

Israel's reserves expanded by $420 million in February, driven largely by the central bank's foreign-currency purchases, the authority reported on Tuesday after signaling earlier in the month that it was prepared to exceed its buying limit. The Bank of Israel wasn't immediately available for comment when contacted by Bloomberg.

The shekel has appreciated 14 percent against the dollar over the past decade, second only to the Swiss franc among the world's major currencies.

“With a robust economy, direct investment into Israel continuing to boost inflows, and a central bank left without effective monetary tools, there's not much to stop the shekel from strengthening,” Reznik said. “Despite the Bank of Israel's interventionist policy over almost a decade, the shekel has continued to strengthen with a few short episodes of declines.”

To contact the reporter on this story: Sharon Wrobel in Tel Aviv at swrobel4@bloomberg.net.

To contact the editors responsible for this story: Dana El Baltaji at delbaltaji@bloomberg.net, Amy Teibel