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Foreign Exchange

Deflation risks raise the stakes for SNB intervention

Speculation over a rise in the Swiss National Bank’s EURCHF floor rose on Tuesday as data showed the Swiss economy had gone deeper into deflation than expected.

SNB reserve data and signs that Swiss bank deleveraging might have peaked also argued in favour of such a move. The Swiss consumer price index dropped by 0.5% on an annual basis in November. That outstripped expectations of a 0.3% fall and all but confirmed that Switzerland will suffer from deflation in the fourth quarter.

Recent activity data has shown the Swiss economy is struggling with the strength of the CHF, and the news on falling price pressure served to underline expectations that the SNB will raise the floor in EURCHF once again to protect its economy.

Figures from the SNB also pointed to further intervention, with the central bank reporting that its foreign currency reserves fell to CHF 229.3billion at the end of November.

SNB reserves have fallen from CHF245.0billion at the end of October and CHF282.2billion at the end of September.

That indicates the SNB has not had to intervene aggressively in the spot market since imposing a CHF1.20 floor in EURCHF on September 6 to stem what it called the “massive overvaluation” of the franc, which threatened to derail the Swiss economy.

Greg Anderson, FX strategist at Citi, said the reserve figures suggested that the floor in EURCHF had gained substantial credibility.

“We generally agree with this assessment, but note that some of the apparent decline in reserves comes from intervention moving from the spot market in to the forward market and not from a complete collapse in safe haven demand for CHF,” he said.

Sebastien Galy, strategist at Societe Generale, said signs that Swiss bank deleveraging might have peaked also argued in favour of further action from the SNB on the exchange rate.

The SNB has been forcing Swiss Banks to deleverage since the end of 2008, a pattern that can be seen in data from the Bank for International Settlements.

But Galy said that Swiss net foreign assets turned positive last month, implying that the deleveraging by Swiss banks out of the US and peripheral Europe might have peaked

He argued the low level of activity from the European Central Bank’s securities markets programme in the peripheral bond market, as well as sharply reduced pressures in the USDCHF basis swap market, supported this theory.

With that upward pressure on the CHF abating, the headwinds against a move higher EURCHF have lessened, encouraging the view that the SNB will put its credibility to the test and raise the floor in EURCHF.

Most believe the SNB will act after its policy meeting on December 15, with UBS predicting a rise in the EURCHF floor to 1.25.

Others are more aggressive, given that by some measures, purchasing power parity suggests that EURCHF should be closer to 1.50 than where it stands now around 1.24.

“ It would be very surprising if the SNB responded to this very threatening set of economic and financial challenges with only a small increase in the floor, “ said Michael Derks, chief strategist at FxPro. “ Our sense is that the ceiling will be raised to at least 1.30 when it meets on December 15.”

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