The heads of Bank of Israel today followed the foreign currency market along with hundreds of thousands of citizens. Like most of those citizens, they watched the shekel devaluation with worry and breathed a sigh of relief as the shekel recovered ¿ although not for the same reasons.

Citizens don't like devaluation because it eroded their financial assets. Devaluation is usually les scary for the central bank, but when it happens two days after raising monetary interest, even a central bank has something to lose.

Bank of Israel's spokesman refused to answer the question of whether the bank is considering an imminent change in interest rates, before the last Monday in June, the regularly scheduled date for declaring the July monetary program, but the market is shouting the question.

Presumably, the central bank is in a trap: if the situation demands another rate hike soon, this could constitute admission of error. On the other hand, if considerations of prestige delay the decision until the end of June, the possible continued devaluation could threaten price stability. Despite Bank of Israel¿s many mistakes of the past six months, it appears that this time it will prefer the good of the economy to its own prestige.

The dilemma could be more than theoretical, not just because of how sharply the shekel has fallen since the declaration of a 1% rate hike, but for at least two more interrelated reasons.

1. It is true that the central bank has direct influence only on short term shekel interest, but until now the entire market took that as its directional signal. Now this is changing ¿ bond yields incorporated the interest rate hike even before the central bank announced any move, and they still incorporate interest rate hikes. Fixed interest bonds have 9.5% yields right now. Bank of Israel is losing its position of a market leader to one dragged behind the market, sort of like the international ratings agencies that update their ratings long after the market has done so in practice.

2. One reason for Bank of Israel's market leadership in the shekel sector is naturally its monetary loans to the banking sector, but it is neither the only reason nor the most important. The leadership was granted due to the great respect the market has for its moves and analysis. In other words, the fall of its status on the market doesn¿t just damage the effectiveness of its decisions, but testifies even indirectly to the erosion of its credibility.

The most dangerous thing that can happen to an economy is the loss of its central bank's credibility, the symptoms of which are loss of influence over financial markets. This is even more dangerous when the government is showing fiscal frivolity. It is even more dangerous when a large portion of the business sector is exposed to foreign currency loans. It begins to be really concrete when the banking sector is already embroiled in a crisis that threatens to cause financial suffocation. It is especially problematic when the economy is in deep recession and employment is rising. And when the once-uncontested economic leader finds himself dragged along by events, it can be fatal.