The SNB gets together on Thursday for its first quarterly meeting of the year, with the upward pressure on its currency having eased.
Indeed, flow data from UBS shows that last week saw the strongest buying of EURCHF from its clients since the European Central Bank eased tensions in the eurozone sovereign debt market last September by announcing its OMT bond-buying programme.
Still, the SNB should reiterate its often-stated intention to enforce the SFr1.20 floor in EURCHF “with the utmost determination”.
After all, while it has not had to intervene to enforce the floor since August, the SNB’s FX reserves still stand at a record of SFr428 billion, accounting for more than 70% of Swiss GDP. Furthermore, while the value of the Swiss franc might have stabilized in recent months, its real effective exchange rate still stands 16% higher than pre-crisis levels.
| Swiss franc remains overvalued |
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The consequence of what the SNB describes as the “excessive overvaluation” of the Swiss franc has been an economy mired in deflation for 18 months, and one which now is showing increasing signs of an economic slowdown.
However, any temptation that the SNB might have to raise the floor should be tempered by the prospect of a re-eruption of tensions in the eurozone debt market.
Should the central bank raise the floor and then witness the escalation of concerns over the eurozone – say if Italy forms a new government that petitions for a relaxation of austerity measures or if Cyprus requires a bailout – then haven flows into the Swiss franc will surge once more.
That would see the SNB’s FX reserves, the management of which the central bank has already described as a problem, rise to fresh record levels.
| SNB FX reserves still at record levels |
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The SNB does have other measures at its disposal, however, to fight strength in the Swiss franc to combat deflation and to promote growth in its economy.
Valentin Marinov, strategist at Citi, says the SNB could consider omitting the lower bound if its three-month Libor target rate, which stands at from 0% to 0.25%.
He says the absence of the lower target bound would signal the SNB’s willingness to tolerate negative rates on excessive bank reserves and build on recent measures by large Swiss banks to penalize institutional clients holding Swiss franc deposits.
While the actions of the large Swiss banks at the time were seen as measures to boost their own profitability, they also make it easier for the SNB to show more flexibility on its policy rates.
“The Swiss banks could pass on the costs of holding excess cash to their customers if needed,” says Marinov.
“Indications that the SNB is willing to tolerate negative rates could add to the cyclical headwinds for the Swiss franc across the board.”
Ultimately, the success of such measures will depend on the situation in the eurozone, with capital preservation likely to override investors’ worries over the interest rate penalties of holding Swiss francs, should the eurozone debt crisis deteriorate sharply.
However, if the situation in the eurozone remains relatively stable, then the attractiveness of the Swiss franc as a carry trade funding currency should increase as a result of negative rates.
In time, that could allow the SNB to raise the floor in EURCHF, much to the relief of the country’s export sector.