As of writing, the shekel was lording it over the greenback, which was diving to NIS 4.76 in Sunday's shekel-dollar options trade. In other words, the dollar shrank to 5% below its peak value on the local market.

No question, this development took everybody by surprise, or almost everybody. TheMarker couldn't poll absolutely everybody, this is true. One person who got it pretty close was Bank Hapoalim chief analyst Ptahiya Bar-Shavit, who said on June 19 that the Bank of Israel's rate hike, and the treasury's emergency economic package, would halt the shekel's erosion, leaving it to fluctuate between NIS 4.80 to NIS 4.95 to the dollar.

Investec estimated a range of NIS 4.87 to NIS 4.95, meaning the analysts expected the shekel to shrink some more, though they declined to explain why. Most analysts predicted that the shekel would continue to erode.

But then when the shekel started to regain value, not only hadn't the analysts predicted it, they didn't believe the evidence before their eyes. Aside from Shimon Segev of Menorah Gaon's mutuals department, just about everyone figured the shekel's appreciation was momentary, and that its trend would reverse.

Wrong. How did everyone miss the call? Why was everyone so sure the shekel would continue to weaken?

The key impact on the financial market in June was the Bank of Israel, which raised interest rates by 4.5%. On May 27 the central bank announced a 1% rate rise to 5.6%. On June 9 it updated its monetary policy and raised the rates another 1.5% to 7.1%. Then on June 24, the central bank announced its policy for July, and beefed up interest by another 2% to 9.1%.

The central bank began the process by chasing the markets: bond yields incorporated rate rises of even more than that. After much huffing and puffing, the Bank of Israel finally caught up with its final rate hike. That much is evident from the bond market today, where yields on short-term

makams

indicate a drop in interest rates.

While the market was racing ahead of the Bank of Israel, the shekel kept weakening, and the threat to price stability persisted. But when the gap was erased, the desired effect was achieved: bond yields dropped, yield curves were moderated and the shekel rallied.

There you have it: The analysts didn't believe the Bank of Israel could re-establish its credibility that fast, after it shocked analysts by its 2% rate cut last December to 3.8%.

But apparently the public's faith in the Bank of Israel's devotion to stable prices, and in market discipline, has returned. Therefore the current rate of interest is excessive, in that it more than compensates for the loss of confidence in the central bank.

That may the development that the analysts failed to discern that even when faith in the central bank is diminished, there is a rate of interest at which it still manages to influence the markets.

Another reason to mis-call the sheke's appreciation could lie in the government's fiscal policy. The government has not been taking the steps needed to heal the hurting economy and restore growth. Instead of cutting NIS 10 billion from the budget in 2002, and planning deep cuts in 2003 too, the government has been "adjusting", fudging, raising taxes and its deficit ceiling. Moreover, it has been adopting reforms that increase its deficit even more.

The Bank of Israel deviated from the path of righteousness, but returned. The government is still astray. As long as Silvan Shalom remains finance minister, the government will keep its head firmly jammed in the sand, pundits surmise.

Correct monetary policy alone cannot save the economy, preventing devaluation and rising prices, precluding chaos on the financial markets and dispelling financial uncertainty. It certainly cannot induce the government to reallocate resources.

As the central bank raised interest rates, voices were raised calling on the government to slash its budget. The Bank of Israel made the same call. The government's failure to do so enfeebles the efficacy of the central bank's steps. The worse the damage, the smaller the probability that the shekel will stop weakening.

This is the second reason why nobody expected the shekel's appreciation to accelerate.

Now the analysts are the ones scrambling after the market. Their margins around current rates are thin. Do they have it right this time?

But were they in fact wrong before? Unless the government carries out the cuts everyone is crying for, can the Bank of Israel's high interest rates help restore the influx of foreign investment, and improve the profitability of exports, thus increasing the supply of foreign currency? Can the Bank of Israel alone prevent the rating agencies from downgrading Israel's sovereign credit rating?