The Swiss National Bank’s announcement on March 12 that it was taking drastic steps to breath life into its economy ostensibly signalled a new era of exchange rate management by one of the main central banks. Most market participants had expected the SNB to cut its key interest rates to virtually zero, add extra liquidity through additional repo operations and even possibly introduce quantitative easing. But few, if any, had predicted that the central bank would intervene in the foreign exchange market and actively seek to weaken the Swiss franc.
According to Bank of America/Merrill Lynch, the SNB’s actions have reiterated the central bank’s reputation for actively managing the Swiss economy. “The Swiss National Bank again lived up to its reputation,” the bank writes in a research note, adding: “With a mere 0.25% target for the three-month Libor, the SNB’s rate policy has now hit the trough. In line with the SNB announcement, we look for aggressive quantitative easing through the purchase of Swiss franc private bonds and of foreign currency. The SNB has stayed ahead of the curve. We believe the SNB is – again – setting an example for the much less agile ECB [European Central Bank] next door.”
Inevitably, the SNB’s decision to sell Swiss francs openly in the market – the first time that a main central bank had sold its national currency since 2004 – sparked talk that it had decided to engage in competitive devaluation. And this led to many pondering which central bank would follow its example, with the Bank of Japan identified as the most likely candidate. However, Bank of America believes such views are inaccurate: “We do not view the apparent SNB attempt to bring the exchange rate close to its 2003-2006 average of SFr1.55 per euro as an exercise in genuine competitive devaluation,” it writes. “The SNB is simply meeting the extra demand for Swiss francs that comes from Switzerland’s safe haven status. At the margin, a less overvalued franc may even benefit the many households in central and eastern Europe who had taken out Swiss franc mortgages. This, in turn, could marginally ease some of the recent concerns about the region.”
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“In the current environment, competitive devaluation doesn’t make too much sense” Ulrich Leuchtman, Commerzbank |
Ulrich Leuchtman, head of foreign exchange research at Commerzbank Corporates & Markets, broadly agrees with these sentiments. “You can interpret the SNB’s move as some form of competitive devaluation but I still have doubts that it will become a global phenomenon. In the current environment, it [competitive devaluation] doesn’t make too much sense,” he says. He adds: “Exports can be boosted to an extent by currency weakness, but that can’t compensate entirely if there’s a fall in global demand. Currency moves can dampen the problem, but can’t solve it.”
Derek Halpenny, European head of global currency research at Bank of Tokyo-Mitsubishi UFJ, says that the SNB is extremely worried about deflation and argues that because Switzerland has a small and open economy, the level of the Swiss franc is extremely important. This is the most likely reason why the SNB’s move will be not only tolerated but accepted; it would be an entirely different matter if Japan did the same, which many FX market participants had initially seemed to be predicting. Halpenny also points out that the SNB’s move might well be possibly welcomed because of the impact it has in central and eastern Europe. “It is worth remembering that emerging Europe is suffering in part due to the fact that large portions of loans there were funded through the Swiss franc and yen – two of the best-performing currencies since the crisis began. A weak Swiss franc alleviates this strain for emerging Europe,” he says.
Leuchtman agrees but adds the proviso that substantial problems still face the CEE. “There is a lot of Swiss franc-denominated debt in central and eastern Europe and weakening the Swiss franc limits the problem to an extent, but it doesn’t solve it. The CEE is by no means out of the woods yet. Central banks there are still flirting with the idea of interventions but it’s much harder to strengthen a currency than weaken it and it carries a very high risk,” he says.
So will other central banks respond to the SNB’s intervention with their own forays into the currency market? “I think there is a very low probability of other major central banks intervening in the FX markets,” says Leuchtman. “A strong appreciation of the yen might trigger the type of BoJ action where it ‘leans against the currency’. But the period of yen strength, caused by the perception that it was a safe haven, has waned. The yen was not supported by fundamentals and the repatriation flows are drying up,” concludes Leuchtman.
