Cast your mind back to the start of 2011. The Euro would buy CHF 1.48; 1.29 $; 0.76 £. The Euro came under severe pressure during the European sovereign debt crisis that year and by August; it was approaching parity against the Swiss Franc. This led to a decision by the Swiss National Bank that such appreciation had to stop and a peg was successfully established in September which constrained the Franc to a lower-bound value of €1.2.
The reasons for the SNB decision were easy to understand. The largest single trading partner of Switzerland is the European Union and Switzerland is part of the 4th largest trading partners of the EU (it is a member of EFTA, the European Free Trade Association). Switzerland and its Franc have long been regarded as a safe haven for capital in times of economic uncertainty. Inflow of cash to the Swiss Franc would cause it to appreciate against other currencies, potentially harming exports and the tourist industry.
So what exactly happened?
On Thursday of last week, the SNB pulled the plug on EUR:CHF rate support, as dramatic an act as a doctor switching off life support for a brain dead patient. A statement was issued by the Bank which sought to explain a decision that caught the investment community (and the IMF’s Christine Lagarde) completely off guard:
"The minimum exchange rate was introduced during a period of exceptional overvaluation of the Swiss franc and an extremely high level of uncertainty on the financial markets. This exceptional and temporary measure protected the Swiss economy from serious harm. While the Swiss franc is still high, the overvaluation has decreased as a whole since the introduction of the minimum exchange rate. The economy was able to take advantage of this phase to adjust to the new situation. Recently, divergences between the monetary policies of the major currency areas have increased significantly – a trend that is likely to become even more pronounced. The Euro has depreciated considerably against the US Dollar and this, in turn, has caused the Swiss Franc to weaken against the US Dollar. In these circumstances, the SNB concluded that enforcing and maintaining the minimum exchange rate for the Swiss Franc against the Euro is no longer justified."
Right. It is true that as the Euro came under downwards pressure, it cost the Swiss more and more to maintain the peg as assets needed to be used to buy the Euro. Later this week, the ECB is widely expected to announce a raft of measures to stimulate the Eurozone economy which are likely to involve quantitative easing and further increase (limited!) downwards pressure on the Euro. Prior to the move, on Wednesday night, the Euro stood at 1.20 to the Swiss Franc, a Dollar bought 1.02 CHF, and a Pound Sterling bought 1.55 CHF. On close of trade on Friday, these figures had changed to 0.978; 0.849; and 1.285, representing changes of 18.5%, 16.8% and 17.1%, respectively. In other words, Swiss exports to these markets and tourism to Switzerland had become substantially dearer. The Swiss Market Index has dipped by 12.1% wiping about 100 billion CHF off the value of the market.
Cleaning up the mess
In the aftermath of the SNB move, some foreign exchange brokerages have gone out of business, others are trying to absorb major losses as they must cover positions taken by their clients (the vast majority of whom had short positions against the Franc, assuming it would fall, not rise dramatically). Alpari UK, has ceased trading (it has other branches) as has Global Brokers NZ whereas FXCM saw a 90% decline in its share value in the wake of client losses estimated at the $225 million mark. Many other smaller concerns and individual investors will have gone to the wall last week.
Swiss interest rates and the stability of the currency led to many people securing mortgages in the currency, particularly in Austria and in Eastern Europe. These people have just had their debts mount substantially – by 18.5% (at least) for anybody within the Eurozone. This will have an impact on interest payments which are determined against the loan value (in Swiss Francs). It is entirely possible that some of these individuals will see their homes repossessed in the coming months as they struggle to meet higher repayments.
The Swiss tourist industry will be unhappy at the SNB move. Switzerland has always been an expensive destination for holidays, but the rate change saw large gains in the value of the Franc against all of the major currencies, so it is not just European tourists who will think twice about Swiss vacations – equally, international congresses and conferences in Switzerland just became a lot pricier which will mean delegates for planned events will feel the pain and the attractiveness of Switzerland for future events has taken a hit.
What do the Swiss nationals think?
For Swiss nationals, the news is mixed. Their day-to-day cost of living will probably remain unchanged, but imported goods and raw materials are now cheaper, so some deflationary pressure (well, quite a lot, frankly…) clearly exists. Of more concern is likely to be the effect of the rise on Swiss business with exports hard hit (goods priced in the Swiss Franc have obviously become less competitive whereas the profit margin on goods sold in other currencies will have taken a substantial hit when repatriated to Switzerland). It may be that businesses will need to cut prices, absorbing some of the rate rise, to remain competitive. This is particularly painful within the EU (not just the Eurozone) where demand is sluggish and consumers are already highly price conscious. Poorer competitivity could lead to job losses in Switzerland over time. On the positive side of the balance sheet for the Swiss, holidays abroad are now much more affordable. This new situation could also hit Swiss consumer spending since Switzerland is surrounded by Eurozone nations where products just became a lot cheaper. Swiss membership of EFTA means that they cannot put tariffs on EU goods, so some Swiss are likely to cross the border to go shopping.
It is hard to believe that the SNB could have foretold the magnitude of the appreciation of the Franc prior to Thursday’s move. With a falling oil price, volatility in many stock markets and continuingly weak global demand, the position of the Swiss Franc as a safe haven can only surely have become more attractive. If there are further influxes of cash into the Franc it will appreciate further, putting more strain on the Swiss economy. At the same time, the considerable foreign currency holdings that SNB has amassed (notably in the Euro) have also taken a considerable hit (counterbalanced by the rise in the worth of its own currency, of course). It is not inconceivable, therefore that the SNB may be forced to set another peg against the Euro at a higher rate, if the currency continues to rise.
What does this mean for the currency?
The value of the Swiss Franc against the Euro is now substantially higher than it was three years ago when the SNB first took action. If you take the ratio of the value of the Swiss Franc from Friday to how it stood on August 31 2011, it has depreciated by 9% and 1% against the US Dollar and Sterling, but appreciated by 14% and 40% against the Euro and the Yen, respectively. Perhaps, to that extent, the comments of the SNB quoted above make some sense, but given that trading conditions today are not what they were three and a half years or so ago, it is difficult to fathom why the Swiss would choose to place obstacles in the way of trade with the rest of Europe, if not the world.