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Strong shekel poses inflation headache for the Bank of Israel

The surging Israeli currency is putting pressure on the country’s central bank.

Policymakers at the Bank of Israel have warned that inflation is expected to fall below target as the currency has hit three-year highs in the last month.

Despite robust domestic growth and a brightening world economy, the appreciating shekel has kept a lid on Israeli inflation. Annual consumer prices grew just 0.8 per cent in May – below the BoI’s target range of 1-3 per cent.

The central bank opted to keep its benchmark rate on hold in July at 0.1 per cent – the 27th consecutive month of no change – in a bid to “entrench” inflationary forces in the economy.

The shekel’s real effective exchange rate has risen more than 9 per cent in the last 12 months and leapt 1 per cent since the BoI’s last monthly meeting in June. It is currently trading at 3.548 against the dollar – slipping back from a 2014-high of 3.481 hit last month.

“The inflation rate is expected to decline in the coming months”, said the BoI in its July policy statement. “Inflation expectations for up to the third year remain below the target range.”

Policymakers have been fighting back against currency traders by ramping up the pace of their monthly foreign currency purchases. The BoI snapped up $500m under its natural gas purchase programme between April and May to bring its total FX reserves to just under a third of its total GDP.