On the 15th of January 2015, the Swiss National Bank suspended the minimum exchange rate of CHF 1.20 per euro and lowered its sight deposit interest rate by 50 basis points at -0.75%. This decision came as a surprise. In December, the SNB had reaffirmed the exchange rate remained “the key instrument to avoid an undesirable tightening of monetary conditions”.

Before the cap was introduced in September 2011, the SNB had already been purchasing foreign exchange reserves since 2009… without being able to prevent a 40% appreciation of the CHF against the euro (and in effective terms)! All in all, between 2009 and end of 2014, the SNB increased its holding of foreign exchange reserves from CHF 50 billion to 475 billion (29% in USD and 45% in euro) and its balance sheet swelled from 35% to more than 80% of GDP.

In the introductory remarks, the SNB justified the decision by the recent weakness of the euro exchange rate which caused the CHF to weaken against the USD in particular. While it judges the CHF still high, “the overvaluation has decreased as a whole since the introduction of the minimum exchange rate”. It is also likely that mounting expectations of an ECB quantitative easing have influenced the SNB’s decision. Indeed, should the ECB engage in quantitative easing, the euro exchange rate would be under increasing pressure to depreciate. While there is theoretically no limit to the amount of foreign assets a central bank can purchase to curb the appreciation of its currency, the SNB felt uncomfortable with the current pace of foreign exchange reserves accumulation and “decided that it doesn't make sense to carry on with a policy that is not sustainable and that can only be carried out by constantly intervening in the market”.

Immediately after the decision was announced, the CHF appreciated sharply from 1.20 to 0.98. Consequences are quite clear for the Swiss economy: inflation will remain negative, exports will be hit and GDP growth will be dampened. Concerns about SNB’s insolvency risks however, are overstated: at current exchange rates, the SNB would incur FX losses of more than CHF 75 billion (that is its entire capital). But the SNB cannot be compared to a commercial bank. In particular, it can neither become illiquid, nor go bankrupt. Concerns on its future credibility are more relevant. In particular, if tomorrow the SNB wants to intervene to put a curb on CHF appreciation, its commitment will seriously be tested. One can also believe that it will be more difficult for some for the SNB to use forward guidance as a policy tool.

Consequences for the rest of the world are more ambiguous. On the one hand, Eastern European households that borrowed in CHF have experienced a sharp increase in their liabilities. Fortunately, these practices were clearly receding in most countries and many governments have put in place some FX debt exchange or insurance mechanism.

On the other hand, at a time when many countries (Eurozone countries, Japan, etc.) seek to depreciate, finding a country willing to let its exchange rate appreciate is good news… especially for the eurozone.

 

The Macro Team