Forex Trading: Currency Briefing – Swiss National Bank in conundrum with EUR/CHF floor
An exchange rate for the EUR/CHF around 1.2200 suggests that the franc is overvalued, but depreciation against the euro has so far not happened. Why? According to analysts at Commerzbank, the answer lies in the monetary policy of the European Central Bank.
The ECB has repeatedly stated that interest rates in the Eurozone will remain extremely low for a long time. While the US Federal Reserve has initiated a reversal in its easy monetary policy, by starting a gradual though not “pre-set” tapering of its bond-buying, the ECB’s stance is that it will remain expansionary for some time to come. And given low inflation in the Eurozone, a further rate cut over the coming months remains in prospect, including – as intimated by ECB Executive Board member Benoȋt Coeuré last week – the possibility of negative interest rates.
As the Eurozone debt crisis has eased, the demand for safe-haven currencies has softened. It was the flight to safe havens that triggered a massive appreciation of the Swiss franc during the 2011 crisis and called the Swiss National Bank to arms. In September 2011, Switzerland’s central bank introduced a minimum or floor exchange rate of 1.2000 franc to the euro.
However, the new situation does not mean that all problems are solved for the Swiss franc. The ECB reassured the markets with its promise to do “whatever it takes to preserve the euro”, a commitment closely tied to economic reforms, but this calm came at a cost: the ECB has had to camouflage a lack of reform efforts with its expansionary monetary policy. This state of affairs is putting pressure on the EUR/CHF and the pair is unlikely to appreciate in the short term. In the result, a number of analysts have lowered their 2014 year-end forecast from 1.2600 to 1.2200.
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The SNB’s minimum exchange rate rules out lower EUR/CHF prices but, while it is technically very easy for the central bank to impose and administer this floor, the mechanism involves considerable risks.
The SNB has been open in its concern for an overheating Swiss housing market. A conventional reaction would be a rate hike but this would make the franc more attractive, with the EUR/CHF quickly easing to the minimum exchange rate. In that event, the SNB would have no choice but to increasingly intervene, so increasing the money supply. That would in turn fuel the housing market, which is exactly what the Swiss policy-makers are trying to prevent.
The SNB’s monetary policies targets are said to be autonomous monetary policy, stable exchange rates and the free movement of capital. Assuming that free movement of capital is non-negotiable for the Swiss and in accord with the “impossible trinity model” developed in 1962 by Mundell and Fleming, the SNB must decide between autonomous monetary policy and minimum (fixed) exchange rate.
So far the choice lies firmly with the minimum exchange rate, with the aim being to prevent the franc from coming under excessive pressure, creating deflationary trends. But what, analysts ask, if property prices continue to rise? And what if the ECB becomes yet more expansionary or even begins to buy bonds?
Abandoning the minimum exchange rate would no doubt raise a real risk of deflation – particularly so while the spot price is only just above the floor. That prospect surely means that the SNB will decide to abandon the floor only if it comes under very considerable pressure, an occurrence unlikely through the remainder of this year.
*Editing by Frank Quin*