ZURICH The Swiss National Bank may have to resort to tougher measures to weaken the red-hot Swiss franc because slashing interest rates to zero and pumping liquidity into markets has not had much effect thus far.
The SNB on Wednesday announced it would expand sight deposits to 200 billion Swiss francs ($250 billion), its third round of easing measures in as many weeks.
Talk in the market had been rife that the SNB would announce an exchange rate target, and the announcement on Wednesday disappointed many by not being tougher. This sent the franc up as much as 2 percent against the euro.
SNB policymakers have signaled that in their crusade to tame the currency they are not excluding any options.
Here are some tools available to Switzerland and an assessment of the chances of their being used.
FURTHER BOOST LIQUIDITY
The SNB's strategy since on August 3, when it shocked markets by cutting its benchmark interest rate target to zero, has been to expand liquidity so as to reduce the returns on Swiss franc-denominated holdings, thereby making them less attractive.
The hope is that this will limit the pressure on the franc. Yields on short-dated fixed income products, such as the euro-Swiss futures have already turned negative.
"We think the SNB will continue to fight the rise of the franc in this manner, but the market will fight it too," said Informa Global Markets analyst Tony Nyman.
It is unclear whether boosting liquidity in the money market will actually get translated into a weaker exchange rate for more than a few days: the franc remains a safe haven unit sought by investors worried about debts in the euro zone and the United States.
When asked what the SNB could do next, one forex trader said: "The measures work for now. But if this (debt) crisis really hits and risk is sold off big time, then we go lower euro-Swiss. They need sentiment to change."
INTERVENTIONS/ EXCHANGE RATE TARGET
After the SNB booked its largest annual loss ever due to its market forays in 2009 and 2010, interventions were something of a political non-starter earlier this year.
Yet with the franc's strength hampering exports and labor unions warning joblessness may rise, politicians from both sides of the spectrum are calling for the SNB to intervene in markets to cap the currency.
"It is possible that at some point they will have to intervene because the trust isn't there that the sight deposits will work. Maybe in a week or in two weeks, they might intervene," ZKB economist David Marmet said.
Former SNB Chief Economist Georg Rich and the head of business lobby economiesuisse, Gerold Buehrer, have said the SNB should pursue an exchange rate target -- firing salvos into markets to defend a pre-announced level.
"The repeated liquidity action should be the preliminary to be able to start FX targeting from a higher euro/Swiss level," UniCredit economist Alexander Koch said.
In April 2010, the SNB tried for a few weeks but failed to keep the franc at around 1.43 per euro. Such a move now is fraught with difficulty, analysts say, because the SNB would be forced to give up control over domestic liquidity.
"Unless a currency peg is accompanied by measures to constrain capital inflows (e.g. tax on foreign deposits), the SNB may have to intervene on an unlimited scale. This could spill over to create excess domestic liquidity, exacerbating the SNB's worries over the strong housing market," Michael Saunders of Citi said.
The Swiss government on July 6 ruled out capital controls, though it is expected to make an announcement on the strong currency this week.
Any SNB interventions to halt the franc's march forward could be more effective if it acted in concert with other central banks.
However, with economic growth in both the euro zone and the United States sluggish, there are few signs that the European Central Bank and the U.S. Federal Reserve would take action, since a weak domestic currency helps exports.
Like Switzerland, Japan has also been trying to prevent the yen, which investors also buy when looking for a safe haven, from rising.
PEG FRANC TO EURO
Tying the franc to the euro is another option that has been touted. But, as Hildebrand noted on August 5, that would require a change to the Swiss constitution, which enshrines independent monetary policy.
A peg could be pursued either via interventions that target a given level of the exchange rate (see above) or via capital controls.
On July 6, the Swiss government ruled out capital controls.
TAX ON OFFSHORE DEPOSITS
Switzerland could try to dim investors' appetite for the Swissie by implementing a tax on the assets held by foreigners-- bank accounts or Swiss federal government bonds.
"The SNB is clearly hesitant to act on the demand side after
the unsuccessful intervention that ended in 2010, but on the other hand they may opt for negative interest rates as a further measure," Ursina Kubli of Sarasin said.
However, in the 1970s, when the franc was also rising against major currencies as a result of the oil crises, negative interest rates were tried and failed.
(For analysis on negative interest rates see [ID:nL6E7JC0N0])
Given how open the economy is and that a large portion of the capital flows into Switzerland does not wind up in bank accounts, the measures would be tough to implement.
As board member Jean-Pierre Danthine said last week, some options to tame the franc were more practical than others, though none had yet been excluded from the SNB's toolkit.
A tax on bank accounts would likely rile the key wealth management industry, already grappling with stiffer capital standards and an attack on banking secrecy.
Moreover, a tax on Swiss treasuries probably would not much affect 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.
To ease the impact of the franc on the export and tourism sector, which have been complaining of straightened circumstances, the government could, as it did earlier this year, boost support for various sectors.
A 1.5 billion Swiss franc scheme that includes additional funding for tourism and relief from social security contributions for small and medium-sized businesses is expected, a Swiss newspaper reported on Wednesday. [ID:nL5E7JH02G]
"Tax relief for the corporate sector to support other internal cost cutting measures is a viable way to bring relief in the short term," Koch said.
"Also a lower value added tax rate for the tourism industry is imaginable. In contrast to most other industrialized countries, the Swiss government clearly has fiscal leeway." ($1 = 0.791 Swiss Francs)