IMF warns Swiss of euro debt “headwinds”

The International Monetary Fund (IMF) said on Tuesday the Swiss National Bank (SNB)'s cap on the strong franc was “appropriate”. It expects the economy to recover gradually but warns of ongoing “headwinds” from the euro debt crisis.

Last September the SNB set a floor value of SFr1.20 against the euro as safe-haven flows drove up the value of the currency, hurting the export-driven Swiss economy.

In its annual review of Switzerland the IMF said the currency cap was “appropriate in light of the slow pace of activity and remaining deflation risks” but urged the Swiss authorities to exit the arrangement “with great care”.

While Switzerland’s economic fundamentals and policies are strong, the fund said the country faces risks from the euro zone debt crisis as well as vulnerabilities in its domestic financial sector.

“The lingering uncertainty in the FX markets, especially on the long end, and latest change in dynamics indicate that the SNB’s resolve may be tested in the future,” it said.

That would likely entail “large-scale” monetary expansion to defend the floor, potentially fuelling excessive inflationary pressures.

Internally, loose monetary policy may be fuelling a mortgage credit and real estate bubble, the IMF warned. That bubble puts domestically-oriented banks and insurers at risk, it added.

The IMF said Swiss banks met regulatory capital requirements, but large banks had “a relatively thin layer” of high-quality capital.

The report said regulatory measures, rather than monetary policy tightening, would be the best way to address real-estate bubble worries.

Last month the new chairman of the Swiss central bank, Thomas Jordan, reaffirmed his commitment to the cap, saying the franc is overvalued and that he expects it to weaken.

Some Swiss politicians, trade unions and industry groups have urged the SNB to raise the cap toward SFr1.30 per euro to help struggling exporters and tourism.

But most analysts believe such a move is unlikely as it appears Switzerland’s economy has escaped recession.

The IMF expects the Swiss economy to grow by 0.8 per cent this year, in line with Swiss research institutes, after growing by an estimated 1.9 per cent in 2011. Next year, the IMF expects the economy to expand by 1.7 per cent. Swiss unemployment stood at 3.1 per cent in April.

The Swiss franc

The Swiss franc is a so-called “safe haven” currency, that means that investors and speculators buy it when other currencies, including the euro and the US dollar, are under pressure.

  

The increasing value of the Swiss franc is a source of great frustration for exporters because their goods are more expensive to sell outside Switzerland, particularly in the euro zone.

  

At its highest on August 11 it cost around SFr1.04 to buy a euro. A year previously, it would have cost SFr1.38.

  

When the euro entered circulation on January 1 2002, it cost SFr1.47; at its highest, in October 2007 it cost SFr1.67.

  

The Swiss National Bank has previously emphasised that it does not pursue an exchange rate target, but consistently bases its monetary policy on its legal mandate.

  

This mandate stipulates that “the SNB is required to ensure price stability, while taking due account of economic developments”.