* SNB policy review could see Swiss franc weaken further
* One-month risk reversals indicate euro gains/franc
* Swiss investors expected to invest offshore
By Anirban Nag
LONDON, Sept 17 In a world where prospects of
stronger economic growth and higher market interest rates are
driving the most active currencies, the safe-haven and
low-yielding Swiss franc faces a lengthy period of weakness.
Swiss investors are again looking abroad for returns,
particularly in the euro zone, confident that a recovery is
gaining ground and worries about a debt default have waned.
At home, the Swiss National Bank (SNB) is likely to hold
interest rates at ultra low levels for some time until it
believes the threat of deflation has passed.
With the central bank probably also keeping its cap on the
franc's exchange rate when it meets this week, this all adds up
to a likely fall in the Swiss currency and its weakness against
the euro is expected to accelerate in the next few months.
Switzerland maintained its reputation as a safe place during
the turbulent years that followed the 2008 financial crisis,
even though its biggest bank UBS needed a government bailout.
This created problems for the SNB. The franc rose sharply in
2010 and 2011 as investors, worried about a sovereign debt
default in the euro zone, pushed the Swiss currency close to
parity with the euro.
In response the SNB drew a line in the sand, setting a cap
on the franc of 1.20 per euro in September 2011, aiming to
protect the export-driven economy from recession and deflation.
Every time the Swiss currency neared the cap, the SNB went
into the market to buy euros for francs, pushing the rate back.
Now the Swiss economy is growing robustly and inflation is
absent, giving the SNB little reason to tighten policy or remove
the franc cap when it reviews policy on Thursday.
With the SNB keeping interest rates near zero, the euro has
already risen 2.5 percent against the franc this year
while the dollar has gained 1.2 percent. But that is far
less than the respective rises of 15 and 14 percent both saw
against the yen, the other major safe-haven currency.
Some investors are positioning for this week's SNB meeting
to prompt more weakness in the next few months.
In the options market, one-month euro/Swiss franc risk
reversals, which measure the relative demand for
options on a currency rising or falling, show investors have
been increasingly buying protection against a fall in the franc.
The bias for euro calls, or the right to buy the common
currency against the franc, has risen since the start of this
month. That contrasts with euro/dollar,
euro/sterling and euro/yen, which all
show a distinct bias for euro weakness.
"The very low, and on some occasions even negative, nominal
return on cash in Switzerland has made the local currency less
attractive," said Thomas Stolper, currency analyst at Goldman
Sachs. The firm expects the euro to rise to 1.25 francs in three
months and 1.28 in six, up from Tuesday's 1.2370.
"We expect the SNB to maintain the minimum level for the
euro/Swiss franc at 1.20 and for that rate to remain in place
until the risks of deflation have subsided. At that point, we
would expect the bank to switch back to using interest rates as
its main policy instrument."
That seems a long way off. Swiss consumer prices were 0.1
percent lower in August than a month earlier and unchanged from
a year ago. A Reuters poll last week showed economists believe
the SNB will keep the lid on the franc against the euro at least
until the end of 2014.
"We continue to see euro/Swiss franc trading back over the
next few months to this year's highs of 1.26-1.27 as Swiss
portfolio managers return to foreign markets," said Monsoor
Mohiuddin, chief currency strategist at UBS.
However, Deutsche Bank currency strategist George Saravelos
said Swiss investors' purchases of euro zone assets remained
well below pre-crisis levels.
"It is tough timing the return of this outflow," he said,
adding these investments were an estimated 140 billion francs
below their 2008 peak. But combined with the normalisation in
European risk premia, these flows could see the euro rise.
Saravelos estimates 100-150 billion euros sought safety in
Switzerland during the euro zone debt crisis and that this has
begun to unwind.
This is reflected in a steady fall in sight deposit balances
with the SNB - a broad gauge of Swiss banks' excess liquidity
and of how much the central bank has spent to keep the franc
weak - in the past two months.
Euro zone short-term market rates have climbed despite the
European Central Bank promising to keep rates low for a long
time. The yield premium benchmark two-year euro zone bonds
offer over Swiss debt is near January
Traders said short-dated option strikes are layered around
1.2550-1.2750 francs, which could provide short term resistance.
"Once we break through, real money with its structural
overweight in the Swiss franc will be forced to shift its
position with little in the way till 1.30 francs," said Olivier
Korber, options strategist at Societe Generale.