The Swiss National Bank faces the biggest test of its cap on the franc in two years but may find it easier to defend now than when euro zone breakup fears were rampant and the strategy unproven.
The franc rose to its strongest level since September 2012, brushing up against the 1.20 euro limit the Swiss National Bank introduced in 2011 when the currency’s strength was squeezing exporters and threatening deflation.
Renewed weakness in the euro zone and the European Central Bank’s readiness to use radical measures to kick-start the economy have fired up demand for the franc.
A referendum this month on Swiss gold reserves is also playing a role. While approval seems unlikely, a Yes vote would force the SNB to buy gold alongside any currency interventions.
Still, capital flows into Switzerland have declined sharply from the height of the euro crisis, as have fears that the interventions would spark inflation.
More importantly, the SNB’s success in defending the cap back in 2011 and 2012 means it may not have to intervene on the same scale to fend off any new market challenges..
The SNB shocked markets when it imposed the limit in September 2011 after the currency shot to record highs against the euro. The following year, as fears of a Greek exit from the euro zone grew, traders unsuccessfully challenged the cap. It has since become the backbone of SNB policy.
The latest bout of franc strength is unlikely to prompt such intense purchases, economists say.
The cap was breached only once in April 2012, adding credibility to the central bank’s pledge to defend the policy with the utmost determination and purchase foreign currency in unlimited amounts to do so.
Stagnating prices and faltering economic growth in Switzerland have silenced critics who warned of inflationary risks from the interventions and has underscored the need for the cap to ward off deflation.
The policy has garnered support from exporters and tacit approval from other central banks. The risks from the vast purchases are limited because losses on forex reserves are pure accounting losses, economists say, though the bank will need to unwind the reserves at some point.
This could change quickly if the nation votes on Nov. 30 to oblige the central bank to hold at least 20 percent of its reserves in gold, up from 7 percent currently. However, polls show limited support.
The alternative to interventions would be negative interest rates. But that could add fuel to Switzerland’s real estate boom and prove expensive for its large financial sector.
