Shekel Beating Dollar Means No Win for Israel Governor

When Stanley Fischer took over as Bank of Israel governor eight years ago, exports were growing and home prices were stable. Whoever is chosen as his permanent successor faces a tougher start.

Paring interest rates to cool the shekel’s 8.5 percent rally against the dollar in the past year risks fueling housing costs that have surged more than 70 percent since 2007. Lifting them may strengthen the shekel, already the biggest gainer among 31 major currencies tracked by Bloomberg, and crimp the past decade’s growth engine -- exports. The central bank forecasts shipments will drop 1.1 percent in 2013 compared with an about 7 percent gain the year Fischer began.

“The challenge will be to maneuver between these two opposing problems,” Modi Shafrir, chief strategist of Mizrahi Tefahot Bank Ltd.’s finance division, said in a telephone interview. “Low interest rates are fueling housing demand and prices. At the same time, the strong shekel is hurting exporters and growth is lower than potential.”

The central bank is currently being led by acting Governor Karnit Flug as Prime Minister Benjamin Netanyahu struggles to find a replacement for Fischer, who announced about nine months ago that he was leaving. Netanyahu’s first two choices both withdrew their names.

Complicated Search

On Sept. 23, policy makers led by Flug, 58, unexpectedly cut the key rate by a quarter percentage point to 1 percent to spur economic growth. The central bank forecasts growth will slow to 3.4 percent in 2014 from an average rate of 4.3 percent in the past decade.

During his eight years at the helm of Israel’s central bank, Fischer, who turns 70 tomorrow, led with a U.S. Federal Reserve-style dual focus on employment and economic growth, alongside price stability. He gradually lowered the benchmark rate to 1.25 percent in May from 3.25 percent in 2011 in a bid to weaken the shekel.

Credited with helping the nation weather the global economic crisis better than most developed peers, Fischer said in May the central bank would purchase $2.1 billion in foreign currency by the end of the year to counteract pressure on the shekel from natural-gas production and would continue purchases until a sovereign wealth fund begins operating in the course of 2018. The Flug-led central bank said Oct. 2 it would buy $3.5 billion under this program during 2014.

Stocks Jump

Even with these measures, the shekel, named after a biblical unit of weight, has continued to rise. Prospects for talks between the U.S. and Iran over the Persian Gulf nation’s disputed nuclear program have also buoyed the Israeli currency as the threat of possible military strikes by Israel or the U.S. recedes. Iran denies it’s seeking to build a nuclear bomb.

The shekel appreciated 0.3 percent at 6:03 p.m. in Tel Aviv and has weakened 0.2 percent this month. The yield on the country’s 4.25 percent benchmark bonds rose three basis points to 3.77 percent. Israel’s TA-25 stock index rose 0.8 percent, bringing its gain for the year to 9.3 percent.

While the benchmark has underperformed Standard & Poor’s 500 Index, which rose 19 percent this year, the TA-25 is at its highest in more than two years.

Housing Action

As policy makers cut rates to bolster growth, cheaper borrowing costs have reignited the housing market. Home prices rose 9.3 percent in the 12 months through July, after the pace of increases slowed in 2012, said Daniel Hewitt, an economist at Barclays Plc in London. In comparison, inflation slowed to 1.3 percent in August, the lowest in three months and below the midpoint of the government’s target range of 1 percent to 3 percent for nine of the past 12 months.

“The housing market is starting to heat up again,” Hewitt said. “The government has taken action to increase housing supply, but there will be a lag before this has any effect.”

A cabinet subcommittee approved the formation of a state company to promote the development of rental housing on Sept. 29, and the government is seeking ways to ease bureaucracy hindering the marketing of land and the planning process.

The Bank of Israel has also acted, imposing limits on home loans. The latest step in August capped monthly repayments on new mortgages at no more than 50 percent of household income.

For the bank, the underlying problem in the housing market is inadequate supply rather than pumped-up demand.

‘Forward Guidance’

Even if the next governor decides to continue lowering interest rates, there isn’t much room, said Alex Zabezhinsky, chief economist at Tel Aviv-based Meitav DS Investment House Ltd. The new chief may have to introduce additional monetary tools adopted by other central banks, such as bond purchases and “forward guidance,” a promise to keep short-term interest rates low until specific macroeconomic targets are met, he said.

Israeli Finance Minister Yair Lapid said Oct. 10 in Washington that the government may nominate a governor as soon as this week after the withdrawal of the first two nominees. Acting Governor Flug, who is the first woman to run the bank, even for an interim period, has said she would leave the bank once the next head takes office after being passed over twice.

Three new candidates for the job of governor have already been vetted by a government panel: Mario Blejer, a former Argentina central banker; Zvi Eckstein, a former Bank of Israel deputy governor; and Victor Medina, a onetime Finance Ministry director general and former chief executive officer of United Mizrahi Bank Ltd. Netanyahu, who turns 64 on Oct. 21, is seeking other candidates as well, according to an Oct. 1 report in Yedioth Ahronoth.

“The next governor will find his main arsenal nearly empty,” said Zabezhinsky. “If there’s no change for the better in the economy, the Bank of Israel may have to re-examine the tools it is using.”