Thursday, January 15, 2015

Why Did the Swiss National Bank Unpeg the Swiss Franc?

Updated January 19, 2015

The announcement that the Swiss National Bank (SNB) was allowing the Swiss franc to "readjust" in value took the market by storm.  Switzerland had long been preventing the value of the euro to weaken below 1.20 against the franc, maintaining the cap by printing francs to buy euros in the market to maintain its currency at a value that would keep Switzerland's exports competitively priced in the world's markets.

Here is the wording of the SNB announcement:

"The Swiss National Bank (SNB) is discontinuing the minimum exchange rate of CHF 1.20 per euro. At the same time, it is lowering the interest rate on sight deposit account balances that exceed a given exemption threshold by 0.5 percentage points, to −0.75%. It is moving the target range for the three-month Libor further into negative territory, to between –1.25% and −0.25%, from the current range of between −0.75% and 0.25%.

The minimum exchange rate was introduced during a period of exceptional overvaluation of the Swiss franc and an extremely high level of uncertainty on the financial markets. This exceptional and temporary measure protected the Swiss economy from serious harm. While the Swiss franc is still high, the overvaluation has decreased as a whole since the introduction of the minimum exchange rate. The economy was able to take advantage of this phase to adjust to the new situation.

Recently, divergences between the monetary policies of the major currency areas have increased significantly – a trend that is likely to become even more pronounced. The euro has depreciated considerably against the US dollar and this, in turn, has caused the Swiss franc to weaken against the US dollar. In these circumstances, the SNB concluded that enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified.

The SNB is lowering interest rates significantly to ensure that the discontinuation of the minimum exchange rate does not lead to an inappropriate tightening of monetary conditions. The SNB will continue to take account of the exchange rate situation in formulating its monetary policy in future. If necessary, it will therefore remain active in the foreign exchange market to influence monetary conditions.

When the SNB removed the cap on the value of the franc, its valued immediately soared against other currencies, particularly the euro as shown on this chart:

It now only takes around CHF 0.99 to buy one euro, down from CHF 1.20 before the announcement.

If we look at this graph, we get a sense for why the SNB took this unprecedented move:

The Swiss National Bank has a very substantial inventory of euros on its balance sheet, acquired as the SNB kept buying euros to keep the value of the Swiss franc from rising, an action that was particularly necessary during the Eurozone crisis in late 2009 and 2010.  At the end of the third quarter of 2014, the SNB was sitting on €174,335 million which makes up 44.6 percent of the foreign currencies held on its balance sheet.  With the European Central Bank (ECB) heading towards its own quantitative easing program which will put additional downward pressure on the value of the euro as Europe's own interest rates fall even further, the cost of holding the value of the Swiss franc below the old peg level would likely have become more and more expensive, leaving the SNB with even more euros on its balance sheet that are worth even less.

What can we learn from this?  The spillover effects from central bank monetary policy interventions are interacting with each other, resulting in a series of unintended consequences.  With globalization, one central bank, even a relatively small one like the SNB cannot act without provoking a response in another economy.


  1. Currency markets are beginning to reflect diminished confidence in the system central banks have created. As the currency games continue to ratchet ever higher it is becoming more apparent that we are standing on shifting sand. This was emphasized when the Swiss National Bank surprised markets and eliminated its exchange-rate cap a key source of support for the euro.

    The euro quickly plunged 3.5 percent against a basket of currencies, the most since its 1999 debut and hit an 11-year low against the dollar. The schemes bankers have used for years to hide and transfer debt are coming under attack, if they crumble under the assault it will culminate in a reset of the economic system across the globe. The article below explores the what we face in the next round as these dangerous games continue.

  2. In light of the big currency move last week the crux of what is before us may hinge on "relevant value" rather than inflation or deflation. It is possible that we have been mislead into arguing and debating the wrong issue and should be focused on how our assets compare in value to those of other people around the world. In what is often referred to as the "end game" or the time the global economy will be forced into resetting, I believe the situation will focus on issues of currency and debt valuations.
    These "debt valuations" will include both government and private obligations. If someone is caught holding a worthless currency or is owed money that is washed away or not "properly repaid" they will suffer greatly. This means some people and countries will be big losers as value and wealth shifts to the "flavor of the day" driven by demand or searching for a safe haven. The article below explores why the value of things you own and control are more important than whether we have inflation or deflation.

  3. Maybe the Big Mac index isn't so far out after all.