Switzerland: Strengthening of Swiss franc likely to persist, defense of currency floor becoming harder
November 21, 2014
At the beginning of November, the Swiss franc came under considerable strain and approached the 1.20 CHF per EUR floor established by the Swiss National Bank (SNB) in September 2011. The recent strengthening of the currency stemmed from investors' high appetite for safe-haven assets, including the Swiss franc, amid rising concerns over deteriorating growth prospects for the global economy. Of particular concern are the fragile outlook for the Eurozone, slowing growth in China and ongoing geopolitical tensions.
Even though the SNB declared in its September monetary policy meeting that it would continue to intervene in the foreign exchange market to prevent the franc from surpassing the 1.20 CHF per EUR limit, its objective of containing the franc's further appreciation will become harder to achieve, at least in the near term. The strengthening of the franc is likely to persist in the coming months, mainly due to more pessimistic global growth prospects, but also owing to rising concerns that the European Central Bank’s (ECB) purchase of covered bonds and asset-backed securities (ABS) will not succeed in reviving the Eurozone economy.
Additional pressure came from markets' uncertainty ahead of the upcoming gold referendum. On 30 November, Switzerland will hold a referendum on the "save our Swiss gold" initiative the right-wing Swiss People's Party (SVP) has proposed. The initiative suggests that the SNB should hold at least 20% of its assets in gold, as the Bank's current holding is around 7.5%. The SNB strongly opposes the proposal, and has pointed out that such action would interfere with the conduct of monetary policy in its current form.
Notwithstanding the considerable upward pressure on the Swiss currency, many analysts agree that the SNB's currency floor will hold for the remainder of 2014 and throughout 2015. Vasileios Gkionakis, Head of Global FX Strategy at Unicredit, stated:
It seems that markets may be testing the central bank’s resolve ahead of the upcoming gold referendum. We believe that the SNB will continue to defend the floor with “utmost determination” and – in addition to accumulating more FX reserves if needed – it is likely to increase the supply of liquidity to the Swiss franc money market through the expansion of the banks’ sight deposits. Our central scenario remains for the existing monetary policy framework to remain unchanged in the foreseeable future.
That said, consumer confidence is holding at particularly low levels and the economy is likely to register a third consecutive year of deflation in 2014. Consequently, although the Swiss National Bank's stance toward the currency has hardened, it has gone further in suggesting that other measures might also be considered, including raising the currency floor or implementing negative interest rates. Gkionakis goes on to say that:
[W]ith Swiss consumer sentiment hitting a two-year low, inflation expectations dipping in 3Q14 and potentially heading even lower on the back of ongoing declines in commodity prices, the risk of the SNB taking even more action has increased. If it does, we think that raising the EUR-CHF floor is somewhat more likely than cutting rates into negative territory: the latter would have a more questionable impact (and would likely not be favored by the cantons as, in all likelihood, it would result in lower distributed profits), whereas the former seems like a more direct way of putting downside pressure on the CHF, especially as the policy has gained credibility since 2011.
Author: Ricardo Aceves, Senior Economist