Shekel reverses earlier losses after Wall Street dive and judicial overhaul jitters

The shekel on Wednesday reversed some of its earlier losses while the Tel Aviv Stock Exchange saw declines, after stocks on Wall Street tumbled and investor sentiment was dampened by concerns about the impact of the judicial overhaul and higher interest rates.

The local currency depreciated more than 1% during the earlier part of the day to 3.67 against the US dollar before reversing back to 3.65 in the afternoon in Tel Aviv, trading at around its weakest level in three years. Since the beginning of the month the shekel is down more than 6% against the greenback.

“The market is reacting to Tuesday’s declines on Wall Street but sentiment is also impacted by the political uncertainty and the developments in passing the judicial changes,” Sabina Podval, head of research at Leader Capital Markets, told The Times of Israel. “We are hearing and reading more and more headlines about individuals and firms thinking about moving bank deposits abroad and buying dollars.”

The Tel Aviv Stock Exchange’s benchmark TA-125 index declined 0.5% and the TA-35 index of blue-chip companies slipped 0.2% at the close of trading. That’s after US stocks on Tuesday saw their worst performance this year as worries persist about higher interest rates and their tightening squeeze on the global economy. The S&P 500 fell 2% on Tuesday in its sharpest drop since the market was selling off in December. The Dow industrials lost 2.1%, while the Nasdaq composite sank 2.5%.

On Tuesday, the shekel lost as much as 2% after the Knesset passed the first reading of a bill that makes up a significant part of the controversial judicial overhaul, to cement government control over judicial appointments and constrain the High Court’s ability to review Basic Laws. The ruling coalition’s plan to upend the judiciary has been weighing on market sentiment amid fears over its negative impact on the country’s credit rating, which could trigger an outflow of capital and scare away investors.

Financial Times chief economics commentator Martin Wolf cautioned that the judicial “reforms are mainly a power grab” and called on Prime Minister Benjamin Netanyahu to “think again before he does irreparable damage.”

“The great economic danger created by illiberal democracy, one we can see in many other countries, is of ‘crony capitalism,” Wolf wrote in an opinion piece on Tuesday. “It becomes too easy in such systems for the corrupt to succeed in politics, government, the judiciary and in business. That in turn discourages the entry of honest new competitors into the economy, because it is they who are always most reliant on an independent judiciary and bureaucracy.”

“Insiders have power on their side. Outsiders depend on the rule of law,” Wolf argued.

“The reforms will rip up protections against arbitrary action by the government, threatening individual freedom and legal predictability in a country dependent on foreign investment and a dynamic market economy,” he warned.

On Monday, the Bank of Israel hiked the benchmark interest rate by 50 basis points from 3.75% to 4.25% as it already battles with inflation hovering above 5% and a weakening shekel. The central bank seeks to bring inflation within the government’s price stability target of between 1% and 3%.

Illustrative image of the 100 Israeli Shekel bill, on December 31, 2017. (Nati Shohat/Flash90)

Deputy Bank of Israel governor Andrew Abir told Bloomberg after the rate decision that “political uncertainty” in Israel has impacted the exchange rate and equity markets but the central bank has yet to see any direct impact on capital flows. Abir stressed the importance of strong institutions for the long-term economic outlook, adding that the turbulence may not change Israel’s immediate prospects.

Meanwhile, concerns over continued depreciation of the shekel is pushing expectations that Israel’s borrowing costs will increase and remain high for longer.

A weaker shekel is fueling inflation as it makes imports of gas, food and other products more expensive, which in turn pushes prices up. This in turn could mean that inflation will not cool as smoothly as hoped forcing the Bank of Israel to further raise interest rates to dampen private consumption and demand.

“A weaker shekel could contribute to higher inflation and higher prices for households,” said Podval. “Higher interest rates increase the cost of debt slowing the economy.”

Similarly, economists at Goldman Sachs see the path of the Bank of Israel’s monetary policy being mainly directed by the exchange rate as inflation is expected to be coming under pressure from a weaker shekel making imports more expensive.

“Despite supportive external balances, the shekel has been under depreciation pressures this year due to the combination of domestic political developments and weakness in global equity markets (to which the currency has been strongly linked in recent years),” Goldman economists Tadas Gedminas and Kevin Daly wrote in a research report following Monday’s rate decision. “As we think that the exchange rate plays a crucial role in shaping the inflation outlook in Israel and is one of the main monetary policy transmission channels, if the recent FX weakness persists, this will continue to cast a hawkish shadow over rate prospects in Israel and skews the balance of risks towards higher rates.”

Goldman revised its policy rate outlook and now expects borrowing costs to increase by 25 basis points at the next meeting on April 3 to 4.5%. Before this week’s interest rate decision, Goldman’s forecast was for interest rates hikes to terminate at 4%.

AP contributed to this report.