January 21st, 2015
What Are the Repercussions of the Swiss Franc Currency Cap Removal?
Written by Brett Chatz, Intertrader
The Swiss National Bank removed the 1.20 Swiss Franc per euro cap which caused major ripples in the financial markets.
In a stunning move, the Swiss National Bank (SNB) removed the 1.20 Swiss franc to euro cap on the 15th January 2015, a cap that has been in place for 3 years. After the announcement, the markets experienced chaotic behaviour and the Swiss franc rose almost 30% against the euro. This huge move broke the previous parity against the euro but those gains quickly decreased as the Swiss franc began trading 13% higher against the euro at 1.040.
Chairman of the Swiss National Bank Thomas Jordan stated that the decision to remove the cap was not out of panic but was a carefully planned decision. He also said that he expected the Swiss franc to move back to a more 'sustainable' level. This significant change greatly affected the European equity markets as the SMI Index dropped by over 10%. According to Daniel Sugarman, an ETX Capital market strategist, the pressure on the cap has been increasing for some time but the sudden decision to remove that cap caused the markets to reel.
Period of 'Exceptional Overvaluation' of Swiss Franc is Over
The peg on the Swiss franc was introduced in September 2011 due to the fact that investors were purchasing large amounts of the currency as it was considered to be a safer alternative than the dollar or euro. In the Swiss National Bank's statement on 15th January, they said the franc was no longer experiencing a period of 'exceptional overvaluation'. The Swiss National Bank also said the euro has weakened against the U.S. dollar causing the Swiss franc to also weaken against the dollar.
Therefore, it was no longer necessary for the SNB to enforce the minimum exchange rate between the euro and Swiss franc. The Swiss franc is still trading fairly high but as a whole the overvaluation has decreased since the peg was introduced. Additionally, the SNB cut the main interest rate to -0.75% to ensure that the removal of the peg does not cause monetary conditions to be tightened inappropriately.
How Will the SNB's Decision Affect the Economy?
Foreign exchange strategist at UBS, Beat Siegenthaler said the removal of the minimum exchange rate will probably have a significant effect on the Swiss economy. Some market-watchers expected this peg would be in place for many years and the sudden removal is sure to cause a period of volatility and uncertainty.
More specifically, Siegenthaler says that unless the EUR/CHF exchange rate moves closer to the previous 1.20 peg the economic impact could be significant which can be seen in the reaction of the equity markets. He goes on to say that levels close to parity may make certain investment decisions and businesses unprofitable and when large production volumes are considered this could affect other economies as well.
The CEO of Swatch Group, a Swiss watch maker, said the decision could spell big trouble for Switzerland. He believes it will not only affect the tourism and export industries but also the entire country's economy. The shares of Swatch Group have fallen 15% after the SNB announcement. Analysts believe there may well be a large 'deflationary shock' experienced by the Swiss economy which will be similar to the shock that Switzerland attempted to avoid through the introduction of the peg in 2011.