Sale of foreign currency by Bank of Israel fails to stop shekel devaluation, dollar hits 7-year high

The shekel fell sharply on Monday following the terrorist attack in the south of Israel and the country's declaration of war against Hamas. The dollar jumped by more than 2% against the shekel to 3.93 shekels - its highest level since February 2016. This despite the announcement by the Bank of Israel on the sale of $30 billion worth of foreign currency, in an attempt to curb devaluation.

The bank announced that "it will operate in the market during the coming period in order to moderate volatility in the shekel exchange rate and to provide the necessary liquidity for the continued proper functioning of the markets."

The shekel has been falling against the dollar since Hamas' deadly attack on Israel.

Leader Capital Markets chief economist Yonatan Katz said in response that "the Bank of Israel's move greatly reduces the likelihood of an interest rate increase at the upcoming October 23 meeting, which was also low in view of the expected significant moderation in economic activity due to the war."

In the international markets, the dollar index rose by 0.5% to 106.58 points, the euro weakened by 0.6% to 1.052 dollars.

"The movements in the foreign exchange rate reflects a first and sharp reaction to the serious security escalation and the recognition that this time it is a potentially ongoing event that will have real negative effects on both economic activity and the appetite for risk and the general sentiment in the capital markets," said Ronen Menachem, Chief Market Economist at Mizrahi Tefahot.

The drop in the shekel comes after a day of sharp falls in the local stock market, which erased 63 billion shekels from its value on Sunday. The bond market was cut by 14 billion shekels - the TA-35 and TA-125 indices fell by 6.4% and bond yields jumped by dozens of basis points.

The expected damage to Israel's economy following the war is unknown, but it will surely reach many billions - due to the security spending, the shutdown of businesses in the south and other large areas of the country (for an unknown time), and other factors.

"Unlike the various operations in the south in recent years, which had a minimal effect on the markets, the war that started this weekend is expected to have a more substantial effect," said Ori Greenfeld, chief strategist of Psagot.

"The reason for this is that the markets reflect the Israeli economy and if in the previous operations in the south, the Israeli economy was not substantially harmed, such a scenario this time is too optimistic," Greenfeld added.

As in all rounds against Hamas in Gaza, this time too it is impossible to calculate the price that will be exacted from the Israeli economy as long as one critical figure is unknown: the duration of the fighting.

"Protracted security events have a much greater negative economic potential than short events. The negative potential depends on the duration of the event, the degree of damage, the number of fronts, and the global response to the Israeli response," explained Dr. Gil Bufman, Bank Leumi's Chief Economist, who worked both at the Bank of Israel and at the Ministry of Finance.

The decisive variable is that this time Israel intends to enter a protracted war, at a stage when its economic situation is not optimal - and after the political situation (the internal conflict surrounding the government's moves on legal issues) led to a sharp devaluation of the shekel this year. Israel is dealing with excess inflation and capital leaving Israel on a scale we haven't seen in decades. At the same time, a sharp jump in the yields of American bonds causes an increase in the price of money and the dollar appreciates sharply all over the world, including in Israel.

It is already clear that the Ministry of Finance will have to chart a new course and re-examine the budget for 2024. Revenues will drop dramatically due to the paralysis in the southern region, and the expected decrease in consumption in the entire economy, and on the other hand, expenses are expected to increase significantly. Finance Minister Bezalel Smotrich held a preliminary assessment with all senior officials in the ministry on Sunday, which included discussions on the management of the defense budget, compensation mechanisms for the injured, and the needs of the various sectors of the economy during the fighting.

In the global markets, after the surprise from the strong employment report published on Friday, investors are waiting this week for the U.S. inflation data for the month of September.