The Swiss franc fell almost 10% against the pound yesterday (6 September 2011) to CHF1.3850 after the Swiss National Bank (SNB) announced it would cap the currency's value against the euro. This unexpected move left sterling slightly lower versus the euro.
Having averaged above CHF1.53 from 2006 to 2010, versus the euro the franc had soared to almost parity (a one-to-one exchange rate) in August. The franc's rise largely reflected its status as a perceived safe-haven from the turmoil provoked by sky-high European debt levels. Panicked Greek and Italian depositors might well have contributed to the amount of money flowing into Switzerland.
The SNB sees the overvaluation of the franc as an acute threat to the Swiss economy, fearing it will act as a headwind to economic growth and erode exports. The SNB stated it will no longer tolerate an exchange rate of below CHF1.20 versus the euro, and is prepared to buy foreign currency in unlimited quantities to enforce this exchange rate. Since the target rate is set in euros, markets might assume it will primarily sell francs to buy euros.
The European Central Bank (ECB) appeared to distance itself from the policy by stating the decision had been taken by the SNB under "its own responsibility". The ECB won't be pleased to see its Swiss counterpart pushing up the euro, and for good reason. A stronger euro will make it more difficult for the euro zone's peripheral economies to outgrow their debt burdens. These difficulties could be exacerbated if, as some expect, the US Federal Reserve soon adopts a third phase of quantitative easing (QE3), potentially weakening the US dollar.
Uncoordinated intervention in currency markets has tended to have only a temporary impact. Last year, the SNB's largely unsuccessful attempts to curb the franc's rise led to a record loss for the year of 20.8 billion francs (more than £15 billion at present exchange rates). Switzerland's latest decision to intervene is likely to be a topic of conversation when Finance Ministers and central bankers from the Group of Seven leading economies meet on Friday.
It's too early to say whether the SNB's strategy will meet with long-term success. Markets might test the Swiss central bank's resolve if the euro zone debt crisis intensifies, making it harder to halt the franc’s climb. Conversely, if the SNB continues to believe the franc is overvalued it could decide to weaken it further to stimulate growth. This action could reignite fears of 'currency wars' as countries aggressively compete to devalue their currencies to claim a greater share of world trade.
