Shekel Volatility Soars With Mixed Israeli Economic Data

Israel’s stronger-than-expected fourth-quarter growth is fueling the biggest swings in the shekel in more than three years, as investors struggle to second-guess the central bank.

Implied volatility on three-month options for the shekel has jumped to the highest relative to one-year contracts since August 2011, a sign that traders expect increased fluctuations in the short term. Gross domestic product bounced back after slowing in the third quarter, the Central Bureau of Statistics in Jerusalem said on Monday, a day after it said annual consumer prices declined the most in seven years in January, their fifth monthly drop.

“If, after the inflation data, there was a probability the Bank of Israel could cut interest rates as early as next week, now this possibility is very unlikely,” David Reznik, the head of fixed-income research at the capital markets division of Bank Leumi, the country’s second-biggest lender by assets, said by phone from Tel Aviv on Tuesday. “Shekel volatility is spurred by uncertainty about the direction of the central bank’s monetary policy and we expect volatility to continue until there is direction.”

Investor uncertainty echoes the dilemma faced by the Bank of Israel and Governor Karnit Flug, who must decide whether the growth data outweigh the need to tackle deflationary pressures with expansionary policy. Shekel bulls have made it the second-best performer among 31 major currencies tracked by Bloomberg this year, suggesting the GDP data will carry more weight.

‘Need to Act’

Israel’s economy grew an annualized 7.2 percent in the final three months of last year, compared with the 2.7 percent median estimate in a Bloomberg survey of economists. Economic growth accelerated from 0.6 percent in the previous quarter, while the full-year 2014 expansion was revised up to 2.9 percent from 2.6 percent.

Consumer prices fell 0.5 percent in January from a year earlier, beating 0.3 percent median estimate compiled by Bloomberg. They dropped 0.9 percent from December. The government’s inflation target is 1 percent to 3 percent.

“The economy is still growing at a slower pace than its potential while deflation pressures are growing, which is increasing the need for the central bank to act and cut rates to trim shekel appreciation,” Idan Azoulay, the chief investment manager at Tel Aviv-based Epsilon Investment House Ltd., said by phone on Tuesday.

Shekel Rally

The central bank said in December it’s examining other policy tools beyond rate cuts to bring inflation back to target. It resumed foreign currency purchases in 2013, bringing reserves to a record high of $87.6 billion in August.

The shekel has strengthened 1.2 percent against the dollar this year, the best performer after the Swiss franc. The difference between implied volatility on three-month options and one-year contracts rose to 0.63 percentage point on Feb. 16, the highest in more than three years. It has since declined to 0.60 percentage point.

The shekel depreciated the most since 1998 last year after the central bank trimmed borrowing costs to a record low 0.25 percent in August.

“Using the exchange-rate instrument to target the rate in some fashion would clearly be the option to increase inflation expectations, but nothing has been formulated,” Lars Christensen, the chief emerging-markets economist at Danske Bank A/S in Copenhagen, the third-best forecaster for the shekel in the fourth quarter, said by phone on Tuesday. “In this low yield and low interest-rate environment we have globally this is the kind of thing you need to do.”

Before it's here, it's on the Bloomberg Terminal.