Uncertainty Over Central Bank Hitting Forex Market

BMI View: Uncertainty surrounding the appointment of Israel's new central bank governor is underpinning the ongoing appreciation of the shekel. That said, the BoI will continue to intervene in the forex market to stem appreciatory pressures on the unit over the medium term. In addition, we reaffirm our view that further interest rate cuts are on the cards over the coming quarters.

The appointment of a new governor of the Bank of Israel (BoI) appears fraught with obstacles after former governor Stanley Fischer stepped down on June 30. Although Jacob Frenkel, JPMorgan Chase International's current chairman, was appointed governor on June 23, he announced that he no longer wanted the job on June 29. The decision likely resulted from media reports that he failed to inform the government that he was detained in Hong Kong seven years ago after allegedly leaving an airport shop with an item he hadn't paid for. Netanyahu's second choice, Bank Hapoalim Ltd.'s chief economist Leonardo Leiderman, pulled out on August 2 for personal reasons, two days after he was nominated. Karnit Flug, Fischer's deputy, announced that she would not take the job after the government asked Lieberman to fill the position. Flug is currently serving as a caretaker governor until a new candidate is picked.

Investor's reaction to recent developments has been relatively calm. Yields on Israel's benchmark 4.25% 2023 bond came in at 3.76% on August 6, having increased 2.2% since July 29. That said, the increase was likely caused by the recent spike in US 10-Year Treasury yields, which came in at 2.7% on August 5 and look like they could potentially head higher ( see 'Global - Rising US Yields Bolstering Asset Class Strategy ', August 5). Israel's Tel Aviv 100 (TA-100) equity index gained 1.0% since June 29, trading at 1,098 at the time of writing, well within our 1,050-1,150 target band ( see 'Equities: Still Neutral', July 3).

Yields To Increase Further
Israel 2023 Bond Yields, %

Uncertainty Over Central Bank Hitting Forex Market

BMI View: Uncertainty surrounding the appointment of Israel's new central bank governor is underpinning the ongoing appreciation of the shekel. That said, the BoI will continue to intervene in the forex market to stem appreciatory pressures on the unit over the medium term. In addition, we reaffirm our view that further interest rate cuts are on the cards over the coming quarters.

The appointment of a new governor of the Bank of Israel (BoI) appears fraught with obstacles after former governor Stanley Fischer stepped down on June 30. Although Jacob Frenkel, JPMorgan Chase International's current chairman, was appointed governor on June 23, he announced that he no longer wanted the job on June 29. The decision likely resulted from media reports that he failed to inform the government that he was detained in Hong Kong seven years ago after allegedly leaving an airport shop with an item he hadn't paid for. Netanyahu's second choice, Bank Hapoalim Ltd.'s chief economist Leonardo Leiderman, pulled out on August 2 for personal reasons, two days after he was nominated. Karnit Flug, Fischer's deputy, announced that she would not take the job after the government asked Lieberman to fill the position. Flug is currently serving as a caretaker governor until a new candidate is picked.

Yields To Increase Further
Israel 2023 Bond Yields, %

Investor's reaction to recent developments has been relatively calm. Yields on Israel's benchmark 4.25% 2023 bond came in at 3.76% on August 6, having increased 2.2% since July 29. That said, the increase was likely caused by the recent spike in US 10-Year Treasury yields, which came in at 2.7% on August 5 and look like they could potentially head higher ( see 'Global - Rising US Yields Bolstering Asset Class Strategy ', August 5). Israel's Tel Aviv 100 (TA-100) equity index gained 1.0% since June 29, trading at 1,098 at the time of writing, well within our 1,050-1,150 target band ( see 'Equities: Still Neutral', July 3).

Short-Term Gains Possible
Israel - ILS/US$ Exchange Rate

Short-Term Upside Risks For The Shekel

Ongoing uncertainty over the lack of leadership at the BoI is having a pronounced impact in the foreign exchange market. The Israeli shekel gained 2.5% since June 30, and it currently testing key resistance at 3,548. Upside pressure on the unit will remain strong, mainly on the back of the beginning of gas production in Israel, which will attract significant inflows of foreign exchange in the form of increasing investment and payments by international gas companies. Although Fischer's announced in May that the central bank would purchase US$2.1bn in 2013 to counteract the effect of natural gas production, ongoing uncertainty over the involvement of the BoI in the Forex market could well cause the unit to break resistance over the short term.

That said, given that a strong currency is set to damage Israeli exports, which account for approximately 40.0% of the economy, our core view remains that the central bank will continue to intervene to stem the appreciation of the currency in the coming quarters. We see the shekel trading sideways between ILS3.5000-ILS3.8000/US$ over the remainder of 2013.

Interest rate: Still Dovish

During Fischer's tenure, interest rates in Israel fell 325 basis points. In the latest move, the BoI cut rates twice for a total of 50 basis points in May. The central bank's six-member Monetary Committee, which is charged with undertaking key monetary policy decisions, kept interest rates unchanged at 1.25% for a second month in July. According to Monetary Policy Committee member Reuben Gronau, the vacuum at the top of the central bank did not influence the six-member committee's decision to leave the interest rate unchanged. Indeed, the move reflects our view that drastic rate cuts were unlikely after May (see 'Frenkel's Appointment: Dovish Monetary Stance To Continue', June 25).

Still Dovish
Israel - CPI Vs Policy Rate

That said, we remain confident that further cuts are on the cards over the coming quarters. For one, we forecast consumer price inflation averaging 1.9% in 2013 and 2.3% in 2014, well within the current central bank's current target range of 1.0-3.0%. Moreover, while we see real GDP growth of 3.7% and 3.8% in 2013 and 2014, respectively, compared to 3.2% in 2012, the domestic economy will remain in a soft patch, with austerity fiscal measures set to hit private consumption hard. Finally, we believe that interest rates in the US will remain near-zero in 2013 and 2014, and it is unlikely that the European Central Bank and the bank of England would raise short-term interest rates anytime soon. We forecast interest rates in Israel coming in at 1.0% in 2013 and 0.75% in 2014, before increasing gradually from 2015 onward.

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