SNB abandons euro peg ahead of expected ECB QE

Sid Verma, Solomon Teague
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The SNB has been under sustained fire in its attempt to defend its euro peg in recent years, as ECB loosening and risk aversion increased safe-haven flows. Thursday's rate cuts and the shift in the long-defended policy regime have shocked markets and have far-reaching implications for the euro and eastern Europe.

The Swiss National Bank abandoned its peg to the Swiss franc on Thursday, which set a euro floor of 1.20, and cut rates on sight deposit account balances by 0.5% to -0.75%, the lowest interest rate in history.

The surprise move, made outside of the normal meeting schedule, triggered widespread selling on both EURCHF and USDCHF currency pairs. EURCHF moved as low as 0.8500, having started the day at 1.20, while USDCHF was at one point trading at 0.7406, from 1.0188 at the start of trading.

The news also sent the euro briefly below $1.1600. "This move sees a major buyer of the euro leave the building and opens the way for further/faster EUR weakness," says Société Générale, predicting it would lead to further dollar strengthening and increased risk aversion and FX volatility. The SNB's cap was introduced in September 2011 as an alternative to its previous attempt to resist inflation through buying foreign bonds as a form of quantitative easing.

"The SNB’s decision to abandon the floor and cut interest rates is surprising given inflation remains far below target, FX intervention had not been especially large lately and the stronger CHF introduces more downside risks to inflation projections," says Daragh Maher, FX strategist at HSBC.

James Hughes, chief market analyst at Alpari, says: "It very much seems that around 1.05 for EURCHF and 0.90 for USDCHF are the levels that investors now feel is a better representation of the Swiss currency."

Besides the currency revaluations, the move has had far-reaching implications. Traders have struggled to close positions and banks are struggling to offer prices due to the high volatility and demand, says Hughes, while Swiss and eastern European markets experienced heavy losses.

Switzerland's actions came in response to steadily increasing pressure in recent months. The collapse of the rouble and related tensions in Ukraine, along with weakening stock markets and concerns about weak global growth, have encouraged safe-haven flows into Switzerland, creating upward pressure on CHF.

And with the euro dragging CHF down against the dollar, the SNB decided to free its currency before the dramatic moves that an ECB announcement on QE would surely trigger, say analysts.


"Maybe the SNB knows something we don’t?" asks Paul Marson, chief investment officer of investment management boutique Monogram. "One explanation [for the SNB’s move] is the possibility of euro QE on a greater-than-anticipated scale. Perhaps the SNB decided not to fight the ECB and is unwilling to see a further substantial balance-sheet expansion and suffer the practical difficulties that coincide with the eventual unwinding of those positions."

Jane Foley, senior currency strategist at Rabobank, says: "Although the move has shocked markets, there have been mutterings for some time that the SNB’s huge EUR holdings in its balance sheet could be making this policy more difficult to defend."

In October, SNB vice-chairman of the board Jean-Pierre Danthine suggested that the SNB had no immediate plans to reduce the size of its balance sheet, which then included foreign currency reserves of around SFr462 billion, because it would create downside risks for the currency.

The reserves have climbed from SFr200 billion in mid-2011 to almost SFr500 billion now, notes SG, around 45% of which in euros. "These are now equivalent to 70% of Swiss GDP and have not been without controversy in Switzerland, as reflected in the referendum on the SNB's gold holdings on November 30, 2014," the French bank says.

Simon Derrick, chief currency strategist at BNY Mellon, says: "The SNB clearly expected to see a huge surge of inflows in the week ahead and saw little reason to provide these buyers of CHF with an artificially cheap rate."

Foley says: "The ECB is proving to be very successful in exporting its deflationary threat via the weaker EUR. It can also be argued that by whipping the markets up to a frenzy of anticipation about forthcoming QE, ECB president Mario Draghi’s main target could be to weaken the EUR further. For certain, the sharper the downward trend in the EUR, the harder the task of maintaining the EUR/CHF1.20 floor became."

US private bank Brown Brothers Harriman suggests ECB QE may have felt that much closer today after the European Court of Justice's preliminary ruling yesterday removed a potential barrier to a European sovereign bond-buying programme. "The SNB likely anticipated, as do many market participants, for the euro to come under more pressure going forward," says BBH.

Foley says: "The recent action taken by the ECB to weaken the EUR will only have created more difficulties for the SNB. IMF data have shown that in Q3 holdings of the EUR by reserve managers had already started to slip," suggesting the ECB's rate cuts since June have discouraged traders from buying euros.