The Swiss Franc will remain one of the most desirable currencies in Europe, unless the old Deutchemark is resurrected - Comment by Stuart Thomson, chief economist at Ignis Asset Management
"The Swiss Franc is the new Deutschemark and without the resurrection of the old Deutschemark, it will remain one of the most desirable currencies in Europe. The Swiss National Bank does not appreciate this admiration, despite its own economy's contribution to global savings glut.
"The SNB's decision to peg the Swiss Franc/€uro exchange rate backed by unlimited creation of its domestic currency is "courageous" in the truest Whitehall sense. It subordinates monetary policy to foreign exchange policy and repeats the 1978 peg in a more sophisticated manner.
"The immediate success of the policy in boosting the €uro 8% has been helped by the phoney war that often follows major intervention as markets pause to reflect upon the action. The SNB has contributed by selling forward option volatility to reinforce its commitment to maintaining the peg. Theoretically, this commitment is absolute because it can print unlimited amounts of its own currency.
"However, there are a number of constraints as monetary policy becomes subordinate to foreign exchange policy. In 1978, the stimulus caused inflation to accelerate from 1% to 5% within a year, and eventually peak at over 7% in 1981. Global economic conditions are very different from 1978-81 and the deleveraging and deflationary environment should keep inflation in check. Nevertheless, the conservative central bank will hope its latest bazooka will work after a series of failed FX interventions.
"The success of the 1978 policy lay in the recovery of the US Dollar. The flight to safety into Swiss Francs reflects both the shortage of triple AAA assets and the crisis in Europe. The €uro is not a triple AAA currency and the continuing crisis encourages safe haven flows to the Franc. The success of the 2011 policy rests on an effective resolution of the sovereign debt crisis.
"This has become a war of attrition between politicians, financial markets and the ECB. We believe that it is inevitable that the SNB's commitment will be tested and that the authorities will be forced to back its commitment with negative interest rates, which in practical terms means imposing a charge on large domestic and overseas deposits.
"It is reasonable to assume that the SNB will eventually prevail because the cost of failure is politically unacceptable. But every action has a reaction. Swiss intervention will be invested into triple AAA €uro government bonds, while the currency rebalancing will benefit other triple AAA rated safe havens.
"Japan represents 10% of the SNB's foreign exchange portfolio and attention will undoubtedly focus on the Ministry of Finance/Bank of Japan next week after the G7 meeting at the weekend. Japan was advised to pursue a peg with unlimited currency creation in 1994. 17 years of hurt - so why are we waiting? Six prime ministers in five years and a central bank Governor who does not believe in the effectiveness of monetary policy is testament to serial policy failure. This will not change immediately, but pressures are building for effective policies to weaken the Yen."
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