Will Switzerland Succeed in Keeping the Franc’s Strength in Check?

When in September 2011 the Swiss National Bank (SNB) declared its resolution to maintain a cap on the franc to prevent further deflation, it probably did not imagine that it would get stuck with more euros than it could recycle. Now, almost a year after the SNB’s announcement that it would “no longer tolerate” an exchange rate below 1.20 francs to the euro, the Swiss central bank has kept more euros than expected, the Wall Street Journal (WSJ) reported on 7 August 2012, which in turn raises the question whether the SNB will succeed in keeping the franc down and for how long.

The WSJ quotes data released by the SNB, indicating that the bank’s foreign currency reserves hit a record of 406.5 billion Swiss francs (£266.8 billion) in July 2012 on account of SNB’s efforts to prevent the franc from appreciating further. The WSJ quotes Kit Juckes, chief currency strategist at Societe Generale (SCGLY) in London, noting that the SNB seems to have stopped recycling euro reserves into other currencies, “simply allowing the euro share to increase”.

The SNB deemed the buying of euros necessary for fighting higher deflation as the “safe haven” image of the franc made it attractive for investors. A stronger franc, however, means that Switzerland’s exports are less competitive on international markets.
!m[](/uploads/story/251/thumbs/pic1_inline.png)Despite the positive effect of a weaker franc on the Swiss economy, keeping the 1.20 floor comes for a price, and the price in question is quoted predominantly in euro. With the Swiss central bank accumulating euros so rapidly that it is unable to offload them fast enough, there are doubts how long it will manage to hold on.

According to a recent article in the Financial Times, investors are starting to hedge against the risk of the franc breaking its floor, fearing that the SNB will not be willing to further cap the currency in the face of domestic political opposition to the accumulation of billions of euros. Analysts, on the other hand, are more inclined to think that the SNB will stick to its commitment, with the FT recently publishing the opinion of Mansoor Mohi-uddin, managing director of foreign exchange strategy at UBS (UBSN), who notes that the SNB is more likely to defend in public its policy to cap the franc rather than waver on it due to the risks associated with allowing the franc to soar.

The WSJ recently quoted Serge Gaillard, head of the Swiss government’s labour office, who while acknowledging that the bank had seen a surge in its currency reserves, noted that the SNB could keep the 1.20 floor in place for years, if necessary. “Switzerland has to assume that the nervousness on the currency markets will persist and the euro/franc floor will need to be defended,” he points out.

As noted in a recent Bloomberg article, Maxime Botteron, an economist at Credit Suisse Group AG (CSGN) in Zurich seems to be of a similar opinion, stating that the SNB should be able to keep up the pace of forex interventions for a while, unless there is a massive disruption such as the collapse of the Eurozone. “As they increase liquidity through their purchases, the only limiting factor is inflation. However, that is not a concern at the moment”, she points out.
And while foreign exchange specialists seem to think that the SNB will be able to hold on at least for a while, perhaps the real question is whether the 1.2 floor is worth keeping at all costs. “There’s logic that says they can print Swiss francs until the cows come home, but the problem is they’re not controlling the outcome on the euro side. There’s the risk they’ll be holding an asset that’s viewed as being very poor quality”, notes Steven Englander, foreign exchange strategist at Citigroup (C), as quoted by the FT. The WSJ reports that Mr Gaillard is more optimistic, saying that since the franc has become “overvalued” the demand will at some point disappear. “The SNB would then be able to sell its reserves,” he points out.

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