Scenarios: Swiss left with few options to fight record franc
ZURICH (Reuters) - A shock cut in interest rates to near zero last week failed to halt gains in the Swiss franc and the Swiss National Bank now has to decide on what further steps it could take and whether to embark on costly intervention to ease the currency's appeal.
The 3-month franc LIBOR -- the market rate the SNB targets -- is at its lowest since June 2010, but the franc is seen as one of few safe havens for cash against renewed market turmoil and has hit fresh records against the euro and dollar.
The bank also said last week it would boost liquidity via money market operations. Beyond that it has a limited range of options to weaken the franc, particularly given the losses it racked up trying to stem gains after the 2008 financial crisis.
Most economists say investors will continue to pile into the franc unless concerns over debt problems, growth and banks in the euro zone and the United States can be eased.
Here are some tools available to Switzerland and an assessment of the chances of their being used and impact.
FURTHER BOOST LIQUIDITY TO EASE PRESSURE ON CURRENCY
The SNB could widen its existing program of pumping funds into the money market by failing to renew reverse repos and repurchasing its own bonds, called SNB Bills.
But boosting liquidity in the interbank market is unlikely to get translated into a weaker exchange rate, traders said, because the money market was already awash with funds before the SNB announced its liquidity boosting scheme on August 3.
"In my view the measures won't work. The Swiss money market hasn't really existed for some time," a money market trader said. "If Europe continues to be unable to solve its problems and the US continues to deliver weak data the SNB will have to show its true colors and do something else."
INTERVENTIONS/ EXCHANGE RATE TARGET
The SNB pumped more than a quarter of gross domestic product into markets between March 2009 and June 2010, resulting in its biggest annual loss ever last year and prompting calls for SNB Chief Philipp Hildebrand to resign.
With safe-haven buyers pushing the franc from one record to another, the SNB could again print money and sell francs for foreign currency.
Although the SNB has been heavily criticized for its interventions in 2010 after it ran up a forex book loss of 26.5 billion francs last year, SNB Chairman Philipp Hildebrand said in a newspaper interview on August 5 that he would not put up with further franc appreciation without acting.
Economists generally regard the 2009-10 intervention bout as unsuccessful, and there is little evidence the SNB would fare differently another time round.
"What can the SNB do? With what is going on in the euro zone the franc is the default safe haven for investors and that is unlikely to change anytime soon," Deutsche Bank economist Henrik Gullberg said.
After the record annual loss and the resignation calls, interventions have become politically unpalatable.
Experts, among them former SNB Chief Economist Georg Rich and the head of business lobby economiesuisse Gerold Buehrer, have called on the central bank to pursue an exchange rate target.
That would mean firing salvos into the market to defend a previously announced level of the exchange rate.
But the scheme is risky because the SNB would likely have to inject huge amounts, vastly expanding its balance sheet and likely suffering more harsh criticism, as traders took positions against the level.
In April 2010 the SNB tried targeting a 1.4350 francs per euro level -- but ultimately failed -- by buying the cross on dips.
"They can intervene but I don't think it will make much difference," one currency trader in Zurich said.
LIKELIHOOD: NOT LIKELY
In 2009-10 the SNB intervened on its own, and Japan has also been waging a lonely battle against an appreciating currency of late. Yet were the SNB to coordinate action with other central banks, markets might take more heed.
"To have a real impact, it would have to be coordinated action with other central banks. If the SNB or the Bank of Japan do it on their own, it will be a losing battle," Deutsche Bank economist Henrik Gullberg said.
But pronouncements by officials in Europe and the United States indicated that concerted action is unlikely. The falling euro has been a boon to export-oriented euro zone states such as Germany, and European Central Bank President Jean-Claude Trichet said the Japanese interventions were not part of a 'multilateral process'.
A U.S. official on August 4 said he did not support Japan's move to tame the yen's rise.
PEG FRANC TO EURO
Tying the franc to the euro is another option that has been touted. But, Hildebrand noted on August 5, that would require a change to the Swiss constitution, which enshrines independent monetary policy.
"It's clearly not a first choice," Credit Suisse economist Fabian Heller said of a temporary euro-franc peg. "And given how overvalued the franc is it wouldn't make sense at current levels."
Although the SNB sees economic momentum slowing in the second half of the year due to the unfavorable exchange rate, the Swiss domestic economy is so far still in better shape than that of the euro zone. A peg would also force the Swiss to accept the ECB's policy measures, increasing the risk of an Alpine bubble.
The SNB's ultra-loose policy is already prompting mortgage lending at a rapid pace.
NEGATIVE INTEREST RATES
LIKELIHOOD: VERY UNLIKELY
Switzerland could try to lessen the appeal of the franc by implementing a tax on assets held by foreigners. Among the proposals are taxes on offshore deposits or on Swiss government bonds held by foreigners.
Negative interest rates were tried in the 1970s and failed to cap the franc then, which was surging as a result of the oil crisis, and few believe they would work now.
"The restrictions and controls in cross border trade would be so severe that the economy would suffer more harm," the newspaper Finanz und Wirtschaft quoted former Basel University economics professor Peter Bernholz as saying.
The measure would be hard to implement given how open the economy is, that a large portion of capital flows into Switzerland does not wind up in bank accounts but with hedge funds and other assets, and that it would be hard to determine how much tax to levy, given banking secrecy.
Moreover, a tax on Swiss treasuries probably would do little to move the exchange rate: The Swiss confederation has less than 100 billion Swiss francs in tradable bonds, much of which is placed in the domestic market.
Although the strong franc has hit earnings at banks by raising the relative cost of management fees, a deposit tax would likely also further reduce the attractiveness of the Swiss financial sector, already grappling with stiffer capital regulations and a crusade against banking secrecy by authorities in Germany and the United States.
Yet there have been signs that investors are increasingly willing to pay to place their money in perceived secure locations, the more so after the United States lost one of its triple-A credit ratings on Friday.
"We no longer rule out the introduction of a (negative) penalty interest rate," economists at Sarasin said.
(Additional reporting by Silke Koltrowitz and Rupert Pretterklieber in Zurich, Naomi Tajitsu in London; editing by Patrick Graham)
(By Catherine Bosley)
- Tweet this
- Share this
- Digg this