Israel’s shekel holds a 12% annual gain despite rate cuts

Israel’s shekel has retained most of a powerful rise that began in April 2025, despite successive interest-rate cuts. Its modest retreat from a record peak looks more like an easing of the rally than a reversal. For the Bank of Israel, that strength is doing some of the work of restraining prices while allowing borrowing costs to fall.

The broad nominal exchange-rate index climbed from 108 at the start of the advance to a record 136 in May 2026, before easing to 131 in September. Because this measures the shekel against a basket of currencies, the move is broader than a bilateral gain against the dollar.

Lower interest rates would ordinarily reduce a currency’s appeal, other things equal. But currencies respond to expected returns relative to other markets, capital flows and perceived risk—not just the domestic policy rate. The shekel’s resilience suggests those forces have outweighed the drag from monetary easing.

Israel’s technology sector provides plausible support through foreign investment and overseas earnings converted into shekels. Institutional investors can also amplify appreciation: when their foreign assets rise in value, maintaining currency hedges can require selling foreign currency and buying shekels. A reduction in the risk premium investors demand for holding Israeli assets would reinforce those flows, although that explanation depends heavily on changing security and fiscal expectations. None requires domestic rates to remain unchanged.

The stronger currency likely helped annual inflation fall from 3.12% in July 2025 to 1.55% in July 2026. Appreciation lowers the shekel cost of imported fuel, consumer goods and industrial inputs, with effects reaching retail prices as contracts and inventories turn over. It is unlikely to explain the entire slowdown: domestic demand, global prices and the fading of earlier price increases can also matter.

The policy rate, meanwhile, fell from 4.50% to 3.25% over the year to the latest reading. Falling inflation means lower nominal borrowing costs need not translate into an equally large reduction in inflation-adjusted financing costs. That helps explain why rate cuts and currency strength can coexist without implying that monetary policy has become loose.

Households buying imported appliances or travelling abroad would tend to benefit, while retailers and manufacturers using imported components gain cheaper supplies. Exporters face the opposite pressure. Technology businesses earning foreign currency but paying Israeli salaries receive fewer shekels for their revenue; manufacturers and tourism operators may find it harder to compete. Cheaper imported inputs cushion that squeeze only partly.

The appreciation therefore gives the central bank meaningful, but conditional, room to cut further. It reduces imported inflation and tightens conditions for exporters, strengthening the case for relief to borrowers. Yet a stable currency at a high level does not keep reducing inflation indefinitely: the downward impulse fades once import prices have adjusted.

Further easing should therefore depend on services inflation, wages and inflation expectations—not merely cheaper imports. Security or fiscal deterioration could also reverse currency support quickly. The key test is whether domestic price pressures subside as the exchange-rate benefit fades; if they do, gradual cuts look more sustainable than an aggressive easing cycle.

Analysis by MENACodex. The reasons and effects discussed are our reading; every figure traces to official data.