Inside the FX Storm: Why the Bank of Israel Intervened, and the Mistake It Made

"The operation succeeded, the patient died." It is hard to find a more accurate description of what the Bank of Israel went through over the past week after the revelation that it bought $801 million in foreign currency in May. The purchase was disclosed in a routine weekly report, without any special emphasis. From the central bank’s perspective, it was a professional, technical and justified move, but in the end it emerged from it more damaged than when it entered. The Bank of Israel’s message, in its view, did not change, neither the policy nor the level of transparency. And yet, the bank admits that the market heard something different from what it intended to say.

In the end, a central bank does not operate only through interest rates or foreign exchange reserves, but also through expectations. And expectations are built through clear and consistent communication. When a central bank is silent, it does not cancel the narrative, it simply hands the microphone to others. That is how the head of the Manufacturers Association could declare that the pressure worked, traders who followed every word from the bank felt deceived, and market participants filled the gap with speculation about a governor who caved, regretted it, or was afraid of upsetting Washington.

The irony is twofold. Precisely because the Bank of Israel had repeatedly stressed that it does not intervene in the foreign exchange market, many dismissed the rumors that spread at the end of the last weekend in May, after the quarter-point interest rate cut, that the bank was buying dollars. "It can’t be," they told themselves, "they said they wouldn’t buy." When the purchase was later discovered, almost in passing, the feeling was not only surprise but also a lack of transparency. The delayed transparency was interpreted as non-transparency.

After the storm, the Bank of Israel is explaining the picture as it sees it. In its view, intervention in the foreign exchange market comes in two forms, as a supplementary tool to monetary policy, or as a means of preserving the proper functioning of the market. The May purchase, it says, was carried out solely under the second form. The official policy remained non-intervention, even if the tool itself still sits in the toolbox and is ready for use.

The professional levels at the bank continuously monitor about ten stress and technical illiquidity indicators. They refuse to disclose the exact list of triggers, out of concern that large market players, including international hedge funds, will try to exploit it for quick profits. Conversations with bank officials indicate that there was no clear "specific event" that led to the intervention, but rather a jump in the warning system they had built. In their view, it was a technical event that required an immediate response. Speculators do not announce their moves in advance, and sometimes it is very difficult to distinguish between a short-term financial move and a legitimate real-economy transaction.

According to the bank, the intervention achieved its goal and the market returned to proper function. A short, immediate statement after the event, in the style of, "As part of routine monitoring, an abnormality was identified, the bank acted and the market returned to proper function," might have ended the story at the outset. It would not have revealed the trigger or the exact timing, but it would have prevented speculation.

The Bank of Israel insists that it hid nothing and rejects the criticism. On the contrary, it sees itself as one of the most transparent central banks in the world, reporting in greater detail even than the Swiss. The bank presents only two possibilities for intervention in the market, an announced program such as the one launched in October 2023 when the war broke out and included foreign currency sales of up to $30 billion, or a correction of a point-specific malfunction. But between these two options there is also a third possibility, a point-specific ad hoc intervention that effectively functions as a limited policy. Whether that was the intention or not, that is how part of the market interpreted it.

While the 2023 program was announced in advance and provided a clear framework, this time the action appeared as a retrospective footnote. An announced program creates certainty, a footnote invites suspicion. At the Bank of Israel, they struggle to understand the scale of the reaction, but if a storm was created, the responsibility for it ultimately also lies with them. On the other hand, they note that the reporting mechanism has not changed, they act in real time and report on the seventh of the month, as has always been done.

At the bank, much of the storm is attributed to timing. The purchase was revealed just days after an interest rate decision that all economic players had been waiting for, while manufacturers were warning about the strengthening shekel, and at the Eli Hurvitz Conference there were calls to accelerate the pace of rate cuts. According to the bank, this combination blurred the line between a "technical correction" and a "policy signal." When the shekel continues to strengthen and in the same week the bank buys dollars, even a cautious observer may find it hard to see that as a mere technical coincidence.

And of course, there were interested parties who exploited the opening that was created. The result was the worst possible one for the bank, it did not receive credit for a deliberate intervention, because it says it was not trying to change policy at all, but it also could not escape the suspicion that it intervened and failed. In other words, it had its cake and ate it too.

Behind all this lies a deeper reason why the Bank of Israel is not rushing to fight the strengthening of the shekel. From its perspective, the appreciation is not the problem, but a symptom. The shekel has strengthened by more than 25% since last April and has become the strongest currency in the world against the dollar, but behind the move are real factors, a decline in Israel’s risk premium following the geopolitical improvement, gains in U.S. stock markets and a weakening dollar globally. These forces are difficult to change by buying $800 million, and perhaps not even by buying ten times as much.

The appreciation also has a direct significance for the interest rate path. The pass-through from the exchange rate to inflation is not symmetrical, in a depreciation it reaches about 20%, while in an appreciation it is only about 10%. When inflation is already approaching the middle of the target range and expectations continue to fall, appreciation acts as a deflationary force. That is the message the governor tried to convey at the Hurvitz Conference. Therefore, further appreciation may affect inflation expectations, one of the main factors in setting interest rates.

The Bank of Israel prefers to get ahead of developments and not wait until inflation falls to a very low level before acting. At the same time, in the United States and Europe the direction is different, and inflation is דווקא showing signs of strengthening.

In the end, it is quite possible that the Bank of Israel was right on every technical point, there was a deviation, the purchase was justified and the market returned to proper functioning. But in central banking, it is not enough to be right, the market also has to understand why you are right.