The Bank of Israel's Exchange Rate Policy

19.10.2009
 
The Bank of Israel's Exchange Rate Policy
 
The Bank of Israel operates in the foreign exchange market in situations in which there are unusual exchange rate movements that do not reflect fundamental economic conditions, or when disorderly conditions prevail in the foreign exchange market.
The Bank does not have a specific exchange rate target. The Bank does have estimates of what is known as the equilibrium exchange rate of the shekel, based on the fundamental determinants of the balance of payments of the economy. These estimates typically change over the course of time as economic conditions change; and by their nature, there is a significant range of uncertainty around estimates of the equilibrium rate. Moreover, deviations from estimated equilibrium exchange rates are common and sometimes persistent.
When the Bank evaluates changes in the exchange rate of the shekel, it takes into account not only the exchange rate against the United States dollar, but also the exchange rate of the shekel against other currencies, particularly the euro. This is done because Israel's economy is affected not only by the economy of the United States, but also by the economies of countries within the euro bloc, and others. Each business day, the Bank of Israel publishes the effective exchange rate of the shekel, which is an index of the exchange rates of the shekel against a basket of currencies, whose weights in the index reflect the structure of Israeli trade.
Because the U.S. dollar has weakened considerably against most currencies during the past year, the effective exchange rate of the shekel has appreciated by less than the exchange rate of the shekel against the dollar. For instance, during the six months ending September 30 this year, the shekel appreciated by 10.6 percent against the dollar, but the effective exchange rate of the shekel appreciated by only 3.2 percent.
The Bank of Israel closely follows market developments in Israel and the world. The Bank analyzes the nature of activity in the foreign exchange markets for the shekel, and short and long term trends. In considering changes in the value of the shekel with respect to other currencies, the Bank of Israel takes into account a range of factors, amongst them some that at present support appreciation of the shekel, including the strength of the economy, the success of Israeli exports and Israel's current account surplus. Other factors operate in the direction of a depreciation of the shekel: for instance, imports fell more sharply than exports during the global crisis, and it is likely that they will recover sharply as the global economy recovers; in addition there are indications that foreign investment by Israeli firms and household is beginning to recover, and also that the pace of foreign direct investment into Israel may be slowing somewhat.
It is important that all those exposed to the foreign exchange markets–– among them exporters, importers, borrowers, lenders and investors–– continue to take the uncertainties about exchange rate movements into account, and protect themselves against expected and unexpected movements in exchange rates. Further, foreign competitors are becoming more efficient, and the competition between Israeli and foreign exporters is intensifying. As Israel increasingly integrates into the world economy, all sectors need to continually adjust and adapt to global conditions, primarily by increasing competitiveness.
The Bank of Israel, as part of its responsibility for monetary policy––with its goals of price stability, supporting growth and employment, and financial stability–– will continue to follow closely developments in the foreign exchange market. Nonetheless, we regard the current period of intervention in the foreign exchange market as exceptional, a result of the not yet ended global crisis. We expect that the market will return to a situation closer to that of 1998-2008, when the Bank of Israel did not intervene at all in the foreign exchange market––or at least, that the need to intervene will occur only rarely, in exceptional circumstances.