Israeli Shekel Surges Against Dollar Amid War, Driven by Market Forces

In a surprising economic development, the Israeli shekel experienced a significant appreciation against the US dollar during the past year, reaching its strongest point in 31 years without direct government intervention. In April 2025, the dollar stood at approximately 3.80 shekels, but by April 2026, it fell below 3 shekels for the first time since 1995, hitting 2.99 and later touching 2.79 in May. This appreciation of over 26% in a single year is remarkable, especially occurring during wartime, alongside a substantial deficit and multiple credit rating downgrades.

The shekel's strength outpaced that of other developed nations' currencies, with the global dollar index only declining by about 10% during the same period. This suggests that local factors were the primary drivers. Three main forces contributed to the shekel's rise: a decrease in perceived risk, as indicated by the drop in Israel's Credit Default Swap (CDS) premium from a wartime high of 150 points to around 66-70; a booming high-tech sector, which accounted for $85.4 billion of Israel's $148.8 billion in exports in 2025, coupled with a near doubling of foreign investment flowing back into the country and being converted to shekels; and significant hedging by Israeli institutional investors. As US stock markets, particularly the Nasdaq, rose, these institutions sold dollars to hedge their exposure, automatically strengthening the shekel.

This market-driven appreciation rendered traditional monetary policy tools, like interest rate cuts by the Bank of Israel, ineffective. Despite four interest rate reductions and a narrowing interest rate differential with the US, the shekel continued to strengthen. The expected impact of interest rate changes on the shekel's value appeared to be minimal.

The strong shekel had mixed effects. It contributed to curbing inflation, bringing it down from 2.9% to 1.6%, below the central bank's target, and facilitating the interest rate cuts. However, this benefit was unevenly distributed. While prices of tradable goods decreased, service costs remained high, meaning consumers saw little relief in areas like rent or dining out. The pass-through effect of the dollar's weakening to consumer prices was estimated at only about 10%.

Conversely, exporters bore the brunt of the shekel's strength. With approximately 77% of Israeli exports denominated in dollars, while costs like salaries, rent, and taxes are paid in shekels, each percentage point of shekel appreciation directly eroded exporter profits. Paradoxically, the high-tech sector, a major source of dollar inflows that strengthened the shekel, was also the sector most negatively impacted by this trend.

A notable case illustrating the shekel's impact was a tax dispute over the acquisition of a company, where the tax liability difference amounted to approximately 1.6 billion shekels solely due to the shekel's appreciation between the deal's signing and completion. A creative solution involved paying the tax in dollars, allowing the government to collect funds without further pressuring the shekel. As the year concluded, the shekel's appreciation moderated slightly due to renewed geopolitical tensions, including the ongoing conflict with Iran and increased activity on the Lebanese border. The key question for the upcoming year remains how to systematically address the issue of currency appreciation, with potential solutions involving government measures to reduce fixed shekel costs and lower production expenses.