A New Look at the Swiss Franc

10/25/2012 9:00 am EST

Focus: CURRENCIES

Rumors are swirling around the Swiss National Bank’s policy of establishing a floor of 1.20 for the EUR-CHF. Mike Kulej of FXMadness.com talks about how a change in that policy might play out.

For the past several months, the Swiss National Bank has been buying the euro in “unlimited quantities” in order to prevent more appreciation of the franc. The central bank established a floor of 1.20 for the EUR-CHF and successfully defended it, with the most recent price activity around 1.21. This uptick happened seemingly on pure market action, without additional purchases of the common currency from the SNB. However, to date, the bank accumulated about $450 billion in foreign reserves, roughly double the level from a year ago, which amounts to 75% of total economic output of Switzerland, huge by any standard.

While the SNB maintains its policy, some are starting to suggest that it is no longer necessary. Latest economic numbers are not as bad as feared, with exports falling only 0.7% and inflation dropping by 0.5%. Given the state of the Eurozone, Switzerland’s largest trading partner, these figures do not indicate severe deflation, or a massive slowdown in exports. In addition, the GDP is growing at 1.1% while the unemployment is only at 3%. With the European Central Bank expected to start buying sovereign bonds in massive quantities, which should strengthen the euro, defending of the 1.20 floor may no longer be necessary.

If this turns out to be true, there is still the question of unwinding some of the oversized reserves. Should the euro continue to appreciate over time, the SNB will probably be happy to slowly sell this currency and pocket the profit. Otherwise, Swiss authorities may opt to swap the euros in inventory for other currencies, probably a basket of them. This could easily take months or even years, in order to prevent excessive price swings. Barring new and dramatic global developments, we could see new policies from the SNB soon.

Mike Kulej of FXMadness.com

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