Written by Angelos Delivorias
On 15 January, the Swiss National Bank discontinued its currency ceiling, set at 1.20 Swiss francs to the euro, less than four years after its introduction. The Swiss franc (CHF) appreciated immediately, reaching as much as 0.97 CHF to the euro that day. This currency move has had, and will continue to have, an impact both on the Swiss and the euro area economies: the system that has been in place is described briefly below as well as the consequences of the Bank’s decision.
The system in place until 15 January
A country’s exchange rate can either be fixed or float. Because a currency fluctuation can have impact on the real economy, a country’s central bank might decide to impose a cap on how much its currency can appreciate and/or depreciate and – whenever the cap risks being breached – commit to buying or selling foreign currency to push the value of its currency in the opposite direction.
Switzerland’s central bank (SNB) decided to impose such a cap on the franc in 2011: during the global financial crisis many investors perceived the Swiss franc as safe and purchased large amounts to protect themselves from the market turmoil in the United States and the European Union. The increasing demand for Swiss francs led to its appreciation: from CHF1.67 to the euro in 2007, the franc reached 1.02 in 2011. This made Swiss goods and services more expensive and less competitive than those of other countries. Therefore, the SNB intervened in 2011 and set a ceiling of CHF1.20/euro. Although this move increased investors’ confidence and protected Swiss exporters from the loss of competitiveness resulting from further appreciation, it came at a price. The SNB maintained the cap by printing francs and buying euros in the market, the result was that its balance sheet expanded significantly, with currency reserves rising up to 80% of GDP in 2014.
As can be seen in figure 1, maintaining the ceiling enabled the franc-euro exchange rate to be held steady for more than three years, whereas the effect of abandoning it has been immediate and significant.
Two significant events may have contributed to the SNB’s January decision: in the international scene, the drop in oil prices observed since the end of June 2014 contributed to the fall of the Russian rouble, which has been trading as low as 76.5 roubles to the euro. In the EU, the positive Opinion of the Advocate General in relation to European ‘quantitative easing’ in the case referred by the German Constitutional Court – pending the decision of the Court of Justice itself – is being interpreted by markets as giving the ‘green light’ to the ECB to start quantitative easing (QE) which, in turn, is expected to drive the euro even lower in relation to the dollar, accentuating a slide which has started in June 2014 and may be even further precipitated by the result of the Greek elections on 25 January. In combination, all these factors are likely to spur once again a search for safe havens, leading investors to buy more Swiss francs.
In this context, to keep the ceiling on its currency, the SNB would have to intervene further as it has done since 2011, leading to further growth of its balance sheet. According to the Financial Times, although the Bank could have well chosen to do so (since in theory a central bank can print unlimited currency), any further balance sheet growth ‘might have raised financial stability concerns’. Therefore, the SNB decided that ‘enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified‘.
Reactions and consequences in Switzerland and the EU
Investors on the Swiss stock market reacted immediately, with the main index falling dramatically that day. The same mood of concern was reflected in the Swiss press, in most political parties, and in the Swiss federation of trade unions, which criticised the SNB’s decision.
Switzerland now faces significant challenges: a strong franc may slow down economic growth, by harming exporters, diminishing the competitiveness of Swiss products vis-à-vis EU products and reducing the number of tourists visiting the country. Additionally, it will expose the SNB to sizeable losses on its assets, since a predominant part of them is denominated in euros.
In western/northern Europe, the decision triggered significant bank losses for major currency dealers like Deutsche Bank and Barclays, but the damage seems to be limited to financial intermediaries.
In some Member States however, the decision raised more concerns, since it affected not only the private sector but also a number of households which had contracted CHF-denominated loans with the aim of benefitting from low Swiss interest rates:
- In Greece, around 65 000 households have contracted loans in CHF with losses estimated at 800 million euros. Even though the number is small (those loans represented only 5% of total house loans in 2013), the potential inability of households to service them as a result of the poorer exchange rates will increase Greek banks’ non-performing loans and worsen their already fragile state;
- In Poland, it is estimated that 580 000 households have CHF-denominated loans. Although, according to the chief economist of ING in Poland, the appreciation should have limited impact on GDP growth (‑0.1%), some politicians have already proposed to adopt a support plan for the households concerned, if the exchange rate remains at those levels for a longer period;
- Until recently, Hungary had been the most exposed country in Europe. However, last year, Prime Minister Viktor Orban’s government pushed through a programme converting foreign exchange loans into Hungarian forints, largely diminishing the population’s overall exposure to CHF.
The surprise decision taken by the SNB to discontinue its exchange rate ceiling had short and medium-term consequences, not only for Switzerland but also for the EU. Some of them (the impact on the Swiss stock exchange and western European financial intermediaries) were immediate although damage was limited, but some others (loss in competitiveness and reduced tourism for Switzerland, potential increase of non-performing loans in central and southern Europe) may have longer term consequences.