The shekel has been among the worst-hit emerging market currencies during the recent bout of US-induced volatility, but current and former Bank of Israel (BoI) governors have played down the significance of exchange rate movements for the local economy.
Housing rents in Israel have historically been priced in dollars, as landlords sought to protect themselves against high inflation in the 1980s and 1990s. This dollarization intensified the inflationary pass-through from exchange rate moves, and the BoI was forced into rapid bouts of monetary tightening in 2002 and 2005 after shekel sell-offs.
However, David Klein, governor of the BoI from 2000 to 2005, now a board member at investment group Meitav in Tel Aviv, told Emerging Markets that the level of dollarization in the housing sector is falling, after a seven-year downtrend in inflation.
“The real estate market is related to the exchange rate only by tradition. It has long been my view that the property market will detach itself from the exchange rate. Everybody understands that price stability is here to stay, so there is no point trading in the local market in prices linked to foreign currency,” Klein said.
This phlegmatic approach to the exchange rate echoed the stance taken by Klein’s successor at the BoI, Stanley Fischer, in an earlier interview with Emerging Markets. When the shekel was at its strongest, after appreciating by more than 13% in the preceding 12 months, Fischer said that exporters always demanded action from the BoI when the exchange rate went against them.
“[This] is a problem for some firms, but is not a macro problem. In any case, there is not a lot the Bank of Israel can do,” Fischer told Emerging Markets.
Nevertheless, Inon Dafni, economist at Israel Discount Bank in Tel Aviv, was concerned that the shift of the housing market to shekel pricing may be a slow one, leaving Israelis exposed to inflationary shocks from the exchange rate pass-through.
“Since November 2006, the prices of housing leases have advanced by 3.8% in dollar terms due to the wish of landlords to compensate themselves for the dollar depreciation and due to the lively demand for rented dwellings, which makes this compensation possible. In this context, the pace of transition from dollar-denominated contracts to shekel-denominated contracts is not clear,” said Dafni.
By contrast with most other emerging market currencies, the Israeli shekel has not recovered from the sell-off triggered in May, after US markets adopted a less dovish view of American inflation. Instead, the shekel has continued to weaken, losing as much as 9% against the dollar so far, after the BoI kept rates on hold at 3.5% this week, well below a Fed Funds rate of 5.25%.