(Bloomberg) -- The franc is within striking distance of what was once one of the most heavily defended boundaries in global markets.
Having touched a three-year low of 1.19 per euro on Tuesday, the franc is now less than a centime away of the 1.20 mark at which the Swiss National Bank had its minimum exchange rate until early 2015 -- enforcing it with what the central bank termed “unlimited” foreign exchange interventions.
While the 1.20 level is largely symbolic, the franc’s weakening provides a potential milestone for SNB President Thomas Jordan and his colleagues, that may allow them to start imagining how to take interest rates back into positive territory after a decade on the front lines of unconventional monetary policy.
“We’re getting close to the famous limit, so it’s a relief for the SNB to have the franc where it is, but they’ll want to see a consolidation of the trend before doing anything,” said Nadia Gharbi, an economist at Pictet in Geneva. “From the communication side we might see a slight shift, but the SNB will still remain very prudent. There’s the risk of a trade war and the situation in Italy remains fragile.”
Already, the SNB appears to be scaling back its interventions, taking advantage of a weaker franc thanks to a pickup in euro-area growth and an abatement of investor anxiety about European politics. While last year’s presidential ballot in France put pressure on the franc, the parliamentary election in Italy this year didn’t have the same effect.
Sight deposits, which analysts consider a barometer for the central bank’s market activity, have barely changed since the start of 2018 and already last year the SNB’s intervention tally came to just 48 billion francs ($50 billion), compared to 86 billion francs in 2015 when the central bank unexpectedly abolished the minimum exchange rate and unleashed market pandemonium.
The SNB already ventured a language shift last year when it dropped its old refrain stating the franc was “significantly overvalued” in favor of the new moniker “highly valued.” It has since affirmed that stance, with Jordan saying in an interview published last week that financial markets remain in a “fragile” state and it’s therefore too early to tighten monetary policy.
“I think they’ll be inclined to not intervene as much as they have done,” said Jessica Hinds, an economist at Capital Economics. With the franc’s fair value between 1.20 and 1.30 per euro, she said, “it’s harder to justify on monetary policy and economic grounds.”
The franc stood at 1.19080 per euro at 10:24 a.m. in Zurich on Tuesday.
What Our Economists Say“Currency caps imposed by central banks have done little to prevent the overvaluation of currencies. The Swiss National Bank imposed one to mitigate safe-haven flows triggered by the global financial crisis. However, it was eventually forced to abandon it and the franc surged higher afterward. The appreciation induced by scrapping the cap has since been reversed but the currency retains the initial overvaluation.”
--David Powell and Dan Hanson, Bloomberg Economics
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The Swiss currency may relax further as European Central Bank bond purchases come to an end. That and the eventual moment when Frankfurt-based policy makers finally raise interest rates will both be welcomed by the SNB and give policy makers in Zurich room to raise rates -- currently at a record low of minus 0.75 percent -- themselves. The first hike in more than a decade is seen taking place in the third quarter of 2019, according to Bloomberg’s most recent survey of economists.
While Switzerland avoided a recession after the cap was dropped, this has come at the expense of an expansion of the SNB’s balance sheet. That may have allowed the central bank to rack up some tidy profits, but rising euro-area interest rates have the potential of eating away at the value of its massive regional government bond holdings. Moreover, after having pumped nearly 700 billion francs into markets over the past decade to weaken the currency, the SNB will need to think about withdrawing it again when it’s time for tighter policy.
“It’s not a free lunch,” said Raiffeisen Schweiz economist Alexander Koch. “There could be problems down the road, especially once inflation picks up and they have to withdraw liquidity again.”
(An earlier version of this story was corrected to fix the direction of the move. Updates franc in ninth paragraph.)
--With assistance from Richard Jones
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