Bets against shekel heap pressure on Israeli central bank

Traders have been increasing their bets against the Israeli shekel, putting pressure on the Bank of Israel to keep interest rates on hold and stabilise the currency, despite the cost of a war looming large over the economy.

Short positions — bets on the currency weakening — against the shekel rose sharply in the week following Hamas’s October 7 attack on Israel to the highest level since January 2022, according to Deutsche Bank research.

“For this year short positioning on the shekel has reached an extreme level,” said Rohini Grover, a currency strategist at Deutsche. Over the past two weeks bets against the shekel had risen by more than any other currency that the bank tracks, she added.

The shekel has fallen 3.8 per cent against the dollar since the Bank of Israel on October 9 pledged to sell up to $30bn of dollar reserves to support the Israeli currency. Since the Hamas attack it is down 4.8 per cent.

The decline in the currency puts the Bank of Israel in a bind. On the one hand, it is likely to come under pressure to stimulate the economy through lower borrowing costs in the face of a growth shock, while on the other it will be wary of a weaker currency leading to a jump in the price of imported goods.

On Tuesday, Bank of Israel deputy governor Andrew Abir said that, when setting policy, officials would focus on stabilising the currency rather than on stimulating growth. Those comments, which suggested less of a bias to cutting rates, provided some stability for the shekel, which traded at 4.03 on Wednesday — in line with levels reached the previous day.

Markets had priced in 0.5 percentage points of rate cuts over the next four months ahead of the comments but afterwards scaled that pricing back to 0.2 percentage points. The Bank of Israel will announce on Monday whether or not it will keep rates at the current level of 4.75 per cent.

“The Bank of Israel is worried about currency weakness and that feeding through to inflation,” said Liam Peach, senior economist at Capital Economics. “But it also understands that if they try to force it in a certain direction they could end up just burning through their reserves.”

The central bank had about $200bn of foreign currency reserves at the start of October. This would cover more than two years of Israel’s imports under normal circumstances, and, based on the IMF’s 2022 projections, would amount to four times the country’s gross financing requirements.

“In the event of escalation [of the war], we think the Bank of Israel has sufficient reserves to prevent a full-blown currency crisis, especially as significant financial inflows from abroad will likely support the shekel,” said Simon Harvey, head of currency analysis at Monex Europe.

Pressure on the shekel comes as Israel lays siege to Gaza ahead of a potential ground invasion, with fears growing that the conflict could escalate further.

On Tuesday, credit rating agency Fitch placed its A plus rating of Israel’s debt on a negative outlook, asserting that the risk that actors hostile to Israel, such as Iran and Hizbollah, could join the conflict at scale had “risen significantly”.

Citibank recommended a short position on the shekel this week, warning that the costs associated with the war could soon escalate and that Israel’s central bank might be forced to cut interest rates sooner than expected.

A build-up in short positions can sometimes be a prelude to a sharp rally if traders suddenly cover their positions. However, analysts said there would need to be a catalyst for the shekel to strengthen.

“Even if the short positions are elevated it doesn’t prevent the shekel from weakening further,” said Lee Hardman, a currency analyst at MUFG Bank. “We need to see a de-escalation in the conflict or a surprise rate hike from the central bank for the currency to rise.”