Ever since the introduction of the floor on EUR/CHF at 1.20, there has been a relatively comfortable relationship between the market and Swiss central bank. But with the euro having struggled this year on the majors, EUR/CHF has nudged ever closer to the line in the sand, CHF up 0.80% so far this year with just a further 0.55% appreciation required to hit 1.20 on EUR/CHF.
But no doubt there will be a battle to be had before that point comes. At the time of the announcement last September, the SNB said it would enforce the level with “utmost determination”, being prepared to buy foreign currency “in unlimited quantities”. Even though, in theory, it could buy unlimited amounts of foreign exchange by printing Swiss francs, there are clearly limits in practice and also costs to the domestic economy from doing so. The substantial increase in sight deposits at the SNB has boosted narrow money, currently rising over 200% in annual terms. The SNB will struggle to temper the effects of such increases in liquidity without causing market interest rates to move higher, which would work against its policy of keep the franc from appreciating.
To date, the Swiss regulators have been pushing on the SNB and lenders to keep a check on mortgage lending, given that mortgage costs are so low. A further wall of liquidity from the SNB would further exacerbate this dilemma, leaving the SNB with the option of either mopping it up (sterilising) and pushing up rates or having to take more measures to counteract the risks of credit expansion in the domestic economy. The peg, whilst helping exporters, is certainly not without its costs.
Simon Smith, Chief Economist