World | Europe

January 16, 2015

What Happened With the Swiss Franc? The Short Answer

The Swiss National Bank shocked markets Thursday by abandoning the cap it had set for the past three-and-a-half years on the Swiss franc’s value against the euro.

The decision came despite repeated assurances from SNB officials in recent months that the central bank was committed to defending the currency cap, which has been credited with protecting Switzerland’s export-dependent economy from turmoil in the neighboring eurozone, and limiting the risks of deflation.

Yet the costs and risks associated with keeping the franc from strengthening too much against the euro—which requires the SNB to purchase assets denominated in non-franc currencies, particularly the euro—have become too great. In ditching the cap, the SNB sparked a dramatic rally in the franc, and raised doubts about its own credibility.

Here are five questions about Thursday’s move.

Why did the SNB cap the franc’s value?

During the eurozone’s debt crisis, the Swiss franc, long considered a safe haven in times of stress, appreciated sharply against the euro. That threatened the country’s manufacturers, which sell a significant share of their exports to the eurozone. In September 2011, the SNB set a goal of keeping its currency from rising beyond 1.20 francs to the euro.

Did it work?

The Swiss economy has expanded more rapidly than the eurozone’s in recent years, but inflation remains near zero, suggesting the economy hasn’t escaped the risks of deflation.

Why scrap the peg?

The SNB said that while the franc is still strong, “the overvaluation has decreased as a whole” since they set the cap. Analysts also said the target would have come under increased pressure in coming weeks, particularly if the European Central Bank launches quantitative easing next week as most analysts expect, increasing the supply of euros and likely leading to further euro depreciation.

What does it mean for the SNB?

The central bank faces two immediate problems: its credibility and the potential for major losses on its balance sheet. The reversal may make it harder in the future for Swiss policymakers to persuade investors that its declared intentions are its real intentions. In addition, because the SNB holds a big chunk of its balance sheet in assets denominated in foreign currencies that will have fallen in franc terms, it faces large losses on those holdings.

What are the lessons for other central banks?

The Swiss case shows how hard it is for central banks to maintain supposedly temporary, emergency measures for long periods, and insulate their economies against major external developments. It also underscores how hard it is for smaller central banks such as Switzerland’s to hold back the tide of markets that are driven by the policies of larger central banks such as the ECB and the U.S. Federal Reserve.

 

Text by Wall Street Journal
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