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Last ditch defence of franc intensifies

How many francs does the market need?

(Keystone)

The Swiss National Bank (SNB) has flooded more francs into the market for the second time in a week in an effort to curb the relentless rise of the Swiss currency.

The SNB said on Wednesday it would inject a further SFr40 billion ($55 billion) of liquidity as the franc approaches parity with the euro.

Against the dollar on Tuesday, the franc saw its biggest one-day gain against the dollar in 30 years, hitting a record level of SFr0.7085.

The SNB move is being viewed as a last ditch desperate attempt by the central bank to arrest the rise of the franc. But observers are not convinced it will work given the unresolved debt problems in Europe and the United States that are fuelling a flight to safety to the Swiss currency.

“I do not think this will help a lot,” Daniel Kalt, UBS bank’s chief economist for Switzerland, told swissinfo.ch. “The strong franc is being driven upwards by so many factors that are not in the sphere of the SNB’s influence.”

European leaders have been slated for making a mess of solving the bloc’s debt crisis while the US had its AAA rating cut to AA+ at the weekend. This has weakened investor appetite for European and US bonds and increased demand for the franc.

Reputational risk

The strengthening franc has increased the cost of Swiss goods abroad, hitting the export industry. The tourism sector has also been hurt as Switzerland becomes a more expensive place to visit.

This is not the first time the central bank has intervened in an attempt to cool the franc. A large scale shopping spree for euros last year failed to halt the franc’s upward progress and left the SNB with losses that have so far amounted to more than SFr35 billion ($48 billion).

Last Wednesday the SNB pumped an extra SFr50 billion of liquidity into the markets while slashing interest rates by 50 basis points to a new target range of 0.0 to 0.25 per cent. The latest injection has taken its total output of francs to SFr120 billion.

Ursina Kubli, currencies expert at Bank Sarasin, also doubts that these measures will be enough to halt the rise of the franc. If the SNB fails again, its reputation could take another pounding, she added.

“The SNB needs to be certain that this will work this time or it risks losing credibility in the markets,” Kubli told swissinfo.ch.

Changing times

The renewed input of liquidity reverses the SNB’s policy of mopping up excess francs at the start of the year when economic conditions looked better and fears of inflation were being raised. But now the greatest fear is for a double dip recession to grip the global economy.

Julius Bär bank forex expert David Kohl believes the central bank’s previous forays into the currency markets were premature, but that the time is now ripe for intervention.

“The over-valuation of the franc is now more extreme and could really hurt the Swiss economy,” he told swissinfo.ch. “The economic outlook is different to a year ago which makes intervention more credible.”

“The previous intervention was sterilized by the need to bring it to a halt to prevent the economy from overheating,” he added. “The economy is now more in need of sustained stimulation, but these measures can only hope to cushion adverse conditions, not prevent them.”

Switzerland’s central bank also announced that while it would not on this occasion buy euros directly, it would swap its francs for foreign currencies.

Mortgage pain

The so-called foreign exchange swap transactions, last used by the SNB in 2008, are designed to speed up the increased supply of francs into the markets.

David Kohl believes the move has also been driven by increased demand for francs by eastern European countries that are desperate to ditch mortgages and other loans taken out in Swiss francs some years ago.

Franc loans were popular in countries such as Hungary, Poland and Austria before the financial crisis to take advantage of relatively low Swiss interest rates and the stability of its currency.

The fad has now come back to haunt home owners and even local authorities in countries that saw repayments go through the ceiling as the franc rose in strength.

“A certain threshold [of exchange rates] has been broken and there is now a huge demand for Swiss francs to unwind these credit positions,” said Kohl. “Given the small size of the Swiss market, Switzerland is struggling to meet demand for its currency at the moment.”

The Swiss franc

Swiss cantons adopted a decimalised silver currency based on the Bernese Thaler in 1798.

But with each canton, plus abbeys, banks and foreign sources minting their own version of the currency, there were still hundreds of different coins in circulation.

It was only in 1848 that the newly created Swiss federal government was given sole power to mint money in Switzerland. In 1850,  the Swiss franc – pegged to the French franc – replaced the various currencies that were in use around the country.

In 1865, Switzerland joined France, Belgium and Italy to form the Latin Monetary Union that set a unified value of their currencies based on their gold and silver content to make them interchangeable. The union was disbanded in 1927.

Switzerland stuck to the gold standard, backing up currency in circulation with gold reserves, until 2000.

The Swiss National Bank was created in 1907, and one of its responsibilities was to take over the task of printing money.

In 1945, the franc joined the Bretton Woods system that set up a new set of rules for the international monetary system.

In 2010, some 6.4% of foreign exchange transaction involved the Swiss franc, making it the fifth most traded currency in the world, according to the Bank for International Settlements.

In recent years the Swiss franc has accounted for around 0.1-0.2% of all currency reserves held by central banks. But this still makes it the fifth most popular reserve currency in the world.

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