A month ago the Swiss authorities were still claiming that their currency floor was crucial to prevent a deflation trap. They were right
By Ambrose Evans-Pritchard
5:17PM GMT 15 Jan 2015
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![swiss flag area of alp mannlichen region of bernese highland swiss alpes canton of berne switzerland](http://i.telegraph.co.uk/multimedia/archive/03166/swiss_3166279b.jpg)
The Swiss economy has been muddling through over the past year but the output gap is still -1pc of GDP Photo: Alamy
The Swiss National Bank has lost control. It is the latest in a list of venerable central banks to be overwhelmed by deflationary forces and global economic disorder.
The country is already in deflation. The Swiss franc ended Thursday 13pc higher after the SNB abandoned its three-year efforts to defend a currency floor of 1.20 to the euro. “We have a free exchange rate once again,” said the SNB’s president, Thomas Jordan.
Indeed, but nobody is fooled by the SNB’s attempt to spin this as benign. “This is a huge hit to their credibility,” said Deutsche Bank.
The official statement claimed that the exchange floor is no longer needed and that “overvaluation has decreased as a whole since the introduction of the minimum exchange rate”.
This is eyewash.
This is eyewash.
“They have had to throw in the towel. They couldn’t hold the line anymore,” said David Owen, from Jefferies Fixed Income. “This is going to cause extreme pain for parts of the Swiss economy but the SNB are trapped.”
The franc has been level over the past year on a trade-weighted basis. Even before Thursday morning's events, the exchange rate was 25pc above its decade-long average. It is now 40pc higher. Just one month ago the SNB argued in its quarterly report that currency floor was imperative to stop Switzerland relapsing back into deflation.
![](http://i.telegraph.co.uk/multimedia/archive/03166/swiss_fx_jan_2015_3166240a.PNG)
“In view of heightened deflation risks, the minimum exchange rate remains the key instrument for ensuring appropriate monetary conditions. A further appreciation of the Swiss franc would have a major impact on salary and price structures. Companies in Switzerland would be forced to cut costs drastically again to remain competitive.”
The statement was true then. The threat is much greater now, made all too clear by the howls of protest this morning from the Swiss export sector. Nick Hayek, head of Swatch Group, said the collapse of the floor would cause havoc. "Words fail me. Today's SNB action is a tsunami; for the export industry and for tourism, and for the entire country," he said.
The Swiss economy has been muddling through over the past year but the output gap is still -1pc of GDP, inflation is negative and the KOF index of business sentiment has been slipping lower for two years. On top of this, the country now has to grapple with the likely hangover from its own domestic credit bubble.
The SNB’s Mr Jordan said the end of an exchange floor inevitably requires subterfuge. "You can only end a policy like this by surprise. It is not something you can debate for weeks,” he said.
That may be true. Less justifiable is the failure to come clean after the event and explain exactly why the SNB now judges the damage of eternal currency intervention to be even more dangerous than the threat of a systemic deflationary shock. We are left guessing.
Ernst Baltensperger, the doyen of Swiss monetary policy, flagged the move in an interview with the Neue Zurcher Zeitung on Sunday. He said the peg worked well at first but then became toxic.
![](http://i.telegraph.co.uk/multimedia/archive/03166/swiss_money_base_j_3166245a.PNG)
1) It has created a flood of excess liquidity within Switzerland that will be increasingly hard to mop up once the tide turns, and velocity rises. The monetary base has exploded from 80bn francs to almost 400bn since mid-2011.
2) It has set off a property boom. Flat prices have risen almost 60pc since early 2007 on the Wüest & Partner index. Bank lending has jumped from an historic average of 145pc of GDP to a new peak of nearly 170pc. Such surges usually end badly.
![](http://i.telegraph.co.uk/multimedia/archive/03166/swiss_property_jan_3166237a.PNG)
3) It is provoking a populist backlash from the cantons. Voters are worried that the bank faces mounting liabilities on its books, tantamount to a fiscal liability. The headline figure put about today was a "loss" of 60bn francs - whatever that means in the world of money creation and fictitious central bank accounting.
The SNB’s balance sheet has ballooned to 85pc of GDP. At one point it was buying half the entire sovereign bond issuance of the eurozone. While this reserve accumulation subsided for a while, it is has been building up to a new crescendo as money pours in to Switzerland from Russia, and Greek tensions return to the eurozone. Foreign reserves rose 7.5pc in the single month of December. The Swiss franc floor was already untenable.
The eurozone’s slide into deflation in December – with 5Y/5Y swap contracts showing inflation expectations in freefall – is the last straw for the Swiss authorities.
It means that the European Central Bank can no longer keep dragging its feet on QE. Whether the ECB announces a €1 trillion blitz next week, or just €500bn, funds are already flooding into Switzerland from the eurozone.
The SNB has to pick its poison. It is damned for one set of reasons if it holds the currency peg, and damned for another set if it ditches the peg. Welcome to the world of horrible dilemmas facing modern central banks.
“In view of heightened deflation risks, the minimum exchange rate remains the key instrument for ensuring appropriate monetary conditions. A further appreciation of the Swiss franc would have a major impact on salary and price structures. Companies in Switzerland would be forced to cut costs drastically again to remain competitive.”
The statement was true then. The threat is much greater now, made all too clear by the howls of protest this morning from the Swiss export sector. Nick Hayek, head of Swatch Group, said the collapse of the floor would cause havoc. "Words fail me. Today's SNB action is a tsunami; for the export industry and for tourism, and for the entire country," he said.
The Swiss economy has been muddling through over the past year but the output gap is still -1pc of GDP, inflation is negative and the KOF index of business sentiment has been slipping lower for two years. On top of this, the country now has to grapple with the likely hangover from its own domestic credit bubble.
The SNB’s Mr Jordan said the end of an exchange floor inevitably requires subterfuge. "You can only end a policy like this by surprise. It is not something you can debate for weeks,” he said.
That may be true. Less justifiable is the failure to come clean after the event and explain exactly why the SNB now judges the damage of eternal currency intervention to be even more dangerous than the threat of a systemic deflationary shock. We are left guessing.
Ernst Baltensperger, the doyen of Swiss monetary policy, flagged the move in an interview with the Neue Zurcher Zeitung on Sunday. He said the peg worked well at first but then became toxic.
1) It has created a flood of excess liquidity within Switzerland that will be increasingly hard to mop up once the tide turns, and velocity rises. The monetary base has exploded from 80bn francs to almost 400bn since mid-2011.
2) It has set off a property boom. Flat prices have risen almost 60pc since early 2007 on the Wüest & Partner index. Bank lending has jumped from an historic average of 145pc of GDP to a new peak of nearly 170pc. Such surges usually end badly.
3) It is provoking a populist backlash from the cantons. Voters are worried that the bank faces mounting liabilities on its books, tantamount to a fiscal liability. The headline figure put about today was a "loss" of 60bn francs - whatever that means in the world of money creation and fictitious central bank accounting.
The SNB’s balance sheet has ballooned to 85pc of GDP. At one point it was buying half the entire sovereign bond issuance of the eurozone. While this reserve accumulation subsided for a while, it is has been building up to a new crescendo as money pours in to Switzerland from Russia, and Greek tensions return to the eurozone. Foreign reserves rose 7.5pc in the single month of December. The Swiss franc floor was already untenable.
The eurozone’s slide into deflation in December – with 5Y/5Y swap contracts showing inflation expectations in freefall – is the last straw for the Swiss authorities.
It means that the European Central Bank can no longer keep dragging its feet on QE. Whether the ECB announces a €1 trillion blitz next week, or just €500bn, funds are already flooding into Switzerland from the eurozone.
The SNB has to pick its poison. It is damned for one set of reasons if it holds the currency peg, and damned for another set if it ditches the peg. Welcome to the world of horrible dilemmas facing modern central banks.
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