The Swiss National Bank shocked markets on Tuesday by setting an exchange rate cap on the soaring franc to stave off a recession, discouraging investors anxious about flagging global growth from using the currency as a safe haven.
Using some of the strongest language from a central bank in the modern era, the SNB said it would no longer tolerate an exchange rate below 1.20 francs to the euro and would defend the target by buying other currencies in unlimited quantities. The move immediately knocked about 8 per cent off the value of the franc, which had soared by a third since the collapse of Lehman Brothers in 2008 as investors used it as a safe haven from the euro zone’s debt crisis and stock market turmoil. Analysts said that the SNB should be able to defend 1.20 as it can print unlimited francs but that long-term success depended on efforts to deal with the euro zone’s debt problems.
“The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development,” the SNB said in a statement. “The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities.” The move was seen as a new shot in the currency wars, with Japan expected to try to weaken the yen if the Swiss action diverts more safe-haven inflows into the currency. Gold, which hit a record higher earlier on Tuesday, is also seen gaining. Fears that the world economy may tip back into recession have spurred investors to dump riskier assets such as stocks and seek the relative safety of gold and the franc and yen.
“As the SNB’s pockets are very deep, it should succeed in stabilising the rate above 1.20,” Commerzbank economist Ulrike Rondorf said. “On the other hand, a further depreciation of the franc seems unlikely to us in the current climate. Uncertainty on the market is still very high, with no sign of the debt crisis in the euro zone abating at present,” she said.
The SNB, which holds its quarterly monetary policy review on September 15, said that even at a rate of 1.20 to the euro, the franc was still high and should continue to weaken over time. “If the economic outlook and deflationary risks so require, the SNB will take further measures,” it said.
The SNB has warned that economic growth — already flagging in the second quarter — is set to slow sharply in the coming months as the strong franc makes Swiss exports, from luxury watches to drugs, prohibitively expensive. The franc nearly touched parity with the common currency on August 9.
It dived 8.5 per cent against the euro after Tuesday’s announcement to 1.203 francs at 6:51 a.m. EDT and dropped almost 8 per cent against the dollar to 0.848.
“That was the single largest foreign exchange move I have ever seen,” said World First chief economist Jeremy Cook. “This dwarfs moves seen post Lehman Brothers, 7/7, and other major geopolitical events in the past decade.” Swiss stocks, hurt of late by the strong franc, jumped, with the blue-chip SMI index trading up 4.3 per cent.
EURO ZONE DEVELOPMENTS KEY:
“It will be the direction taken by the euro zone crisis that will determine how successful the SNB will be in protecting the Swiss franc from strength in the coming months,” said Rabobank senior currency strategist Jane Foley.
The SNB also set a formal exchange rate target in 1978 — above 0.80 francs per German Mark — when the franc was soaring in the aftermath of an oil crisis, and successfully defended that rate, but at the price of soaring inflation.
“It worked in the short term, but it came at an enormous cost and led to a huge burst of inflation,” said Simon Derrick, head of currency research at Bank of New York Mellon.
“The move now should work in the short term, but in the long term they are providing investors who are looking to exit the euro zone debt crisis with an easy route.”
The SNB move came just after data showed Swiss inflation eased by more than expected in August, dipping 0.3 per cent from a month earlier, lower than a median forecast in a Reuters poll for a fall of 0.1 per cent.
The SNB temporarily managed to weaken the franc last month after it cut an already low interest rate target to nil on August 3 and boosted the amount of liquidity in the banking system. But the currency jumped again last week as worries about the health of the global economy intensified.
The SNB is seen in a strong position to follow through on the new target after top Swiss politicians and business groups expressed support for the central bank as the economy flags.
Such political solidarity is in contrast to earlier this year when the central bank came under fire for running up a huge loss in 2010 trying to keep a lid on the franc, prompting calls for SNB chairman Philipp Hildebrand to resign.
