Israeli Shekel Strengthens Amid Dollar Weakness and Inflation Easing

The Israeli shekel has strengthened again against the US dollar, trading just below 2.95 shekels per dollar. According to Meitav, the shekel has become the strongest currency globally over the past month, appreciating about 2.5% against the dollar. This outpaces other major currencies such as the euro, which rose 1.5%, and the British pound, which gained 1.8% in the same period. The US dollar itself has weakened to its lowest level in two months.

The dollar's decline and the shekel's rise follow a series of weaker-than-expected economic data from the United States, which have lowered investor expectations for further Federal Reserve interest rate hikes. The dollar index (DXY) has fallen for three consecutive days, reaching its lowest point since May 15. Market probabilities for a Fed rate increase next month have dropped to about one-third, down from roughly 75% at the end of July. A key upcoming event is the release of the July FOMC meeting minutes on Wednesday, which could influence the dollar's trajectory.

US inflation is easing, with Bloomberg reporting a 0.8% annualized rate over the past three months for the overall index and 1.6% for the core index. Core inflation has fallen below 2.5% for the first time since 2021. Inflation expectations and interest rate hike probabilities have also declined, with the chance of a September rate increase now around 30%, compared to 70% earlier in the month. Recent US economic data, including weaker labor market figures and a surprising drop in July retail sales, have contributed to this outlook.

In Israel, inflation has stabilized below the central bank's target but may rise again later this year, according to Rafi Gozlan, chief economist at IBI. He attributes recent inflation moderation partly to temporary factors like the shekel's appreciation. Gozlan expects inflation to return toward the target by the last quarter of 2023, with a 2.2% increase forecast for the coming year. He also notes that real interest rates in Israel remain relatively high, around 1.75% to 2%, making shekel-denominated assets more attractive and supporting demand for the local currency.

Additional positive signs for Israel include July inflation data showing a slight monthly increase of 0.3% but a small annual inflation decline to 1.5%, and encouraging second-quarter GDP growth of 15.4% on an annualized basis (3.6% quarterly), rebounding from a 3.8% contraction in the first quarter. The Bank of Israel is expected to respond to these developments at its upcoming meeting on September 1, with the current interest rate at 3.5%.