A su­per­strong franc hasn’t been the calamity many in Switzer­land pre­dicted

The cen­tral bank spent bil­lions de­fend­ing the ex­change rate cap “De­lay­ing ... would have led to a much worse out­come”

Bloomberg Businessweek (Asia) - - CONTENTS - −Cather­ine Bosley, Fer­gal O’Brien, and Jan Sch­walbe

It was in a small, wood-pan­eled board­room over­look­ing Lake Zurich that Thomas Jor­dan and his col­leagues at the Swiss Na­tional Bank made a de­ci­sion that caught global mar­kets un­awares, in­fu­ri­ated Swiss in­dus­trial lead­ers, and tipped the econ­omy dan­ger­ously close to re­ces­sion.

Sit­ting in that same room a year later, Jor­dan, pres­i­dent of the SNB, the na­tion’s cen­tral bank, is calm as he looks back on his call to scrap a cap of 1.20 francs to the euro. The bank had kept it in place since 2011 in an at­tempt to con­trol the Swiss cur­rency’s run­away strength and avoid fur­ther dam­age to the coun­try’s ex­ports, which make up more than 60 per­cent of gross do­mes­tic prod­uct. “We have no re­grets be­cause we be­lieve it was ex­actly the right de­ci­sion at ex­actly the right time,” he says of the mo­men­tous step, an­nounced at 10:30 a.m. Cen­tral Euro­pean Time on Jan. 15, 2015. “Some­times you have to take tough de­ci­sions.’’

The ex­change rate cap was meant to keep the franc from rock­et­ing in value as out­side in­vestors poured into the Swiss cur­rency, a tra­di­tional haven when the world—and es­pe­cially Europe—is in fi­nan­cial tur­moil. Yet the de­mand for francs and the weak­ness of the euro had be­come too much for the Swiss cen­tral bank to bear. A year ago, Swiss of­fi­cials were spend­ing bil­lions of francs buy­ing euros as the prospect of quan­ti­ta­tive eas­ing by the Euro­pean Cen­tral Bank and fur­ther weak­ness in the euro in­ten­si­fied the up­ward pres­sure on the franc.

From about 1.60 per euro shortly be­fore Lehman Brothers col­lapsed in 2008, the cur­rency went on an un­stop­pable ap­pre­ci­a­tion, al­most reach­ing par­ity with the euro be­fore the ceil­ing was in­tro­duced in Septem­ber 2011. The three-year strug­gle to main­tain the cap re­sulted in a mas­sive buildup in for­eign-cur­rency re­serves. With pres­sure on its cor­ner­stone pol­icy con­tin­u­ing to mount, the SNB an­nounced a 0.25 per­cent charge on de­posits banks hold with the cen­tral bank.

In Jan­uary 2015, Jor­dan, along with fel­low pol­i­cy­mak­ers Jean-Pierre Dan­thine and Fritz Zur­brügg, de­cided to scrap the ex­change rate limit in one quick move, like rip­ping off a ban­dage. “De­lay­ing the de­ci­sion would have led to a much worse out­come for the econ­omy,” says Jor­dan. “The ap­pre­ci­a­tion of the franc would’ve hap­pened any­way.” At the same time, the SNB an­nounced an in­crease to 0.75 per­cent in the de­posit charge.

Sure enough, within min­utes of the cap be­ing re­moved last year, the franc rose as much as 41 per­cent against the euro. When the news hit, at the peak of franc trad­ing, in­vestors were taken by sur­prise, since the cen­tral bank had af­firmed the pol­icy just days ear­lier. Banks racked up mil­lions of dol­lars in trad­ing losses, and a New Zealand-based bro­ker was forced to shut down. Swiss in­dus­try was taken by sur­prise, too. Swatch Group Chief Ex­ec­u­tive Of­fi­cer Nick Hayek was among those who re­acted, say­ing the SNB had un­leashed a “tsunami.” He later de­scribed the cen­tral bank as “weak” and lack­ing lead­er­ship. Among econ­o­mists, as­sess­ments of the SNB’s ac­tion ran the gamut from “brave” to “one of the worst cen­tral bank de­ci­sions ever.”

Swiss eco­nomic growth did suf­fer, with the surg­ing cur­rency mak­ing ex­ports still more ex­pen­sive in the euro zone, its largest mar­ket. Ex­ports to the euro area dropped 8 per­cent in the first nine months of the year. The

econ­omy shrank 0.3 per­cent in the three months through March 2015. Yet it man­aged to eke out growth in the sub­se­quent three months, skirt­ing a re­ces­sion, with com­pa­nies clamp­ing down on costs and boost­ing ef­fi­ciency. Un­em­ploy­ment hasn’t posted a big rise and, with the franc hav­ing weak­ened slightly against the euro in re­cent months to about 1.09, Jor­dan sees growth ac­cel­er­at­ing to about 1.5 per­cent this year from just un­der 1 per­cent in 2015. The SNB pres­i­dent says the franc is still over­val­ued.

Al­though Switzer­land may be fa­mous for ski­ing, watches, and cheese, its growth has his­tor­i­cally been driven by a mix of fi­nan­cial ser­vices, no­tably pri­vate bank­ing, a phar­ma­ceu­ti­cal in­dus­try that in­cludes Roche Hold­ing and No­var­tis, and the man­u­fac­ture of high-qual­ity, tech­ni­cally so­phis­ti­cated goods. For­tu­nately for Switzer­land, some of th­ese high-end in­dus­tries are less af­fected by the strength of the cur­rency. “Given the strong ap­pre­ci­a­tion of the Swiss franc, the econ­omy is do­ing rel­a­tively well,” Jor­dan says, though the sit­u­a­tion re­mains “a chal­lenge for many, many firms.”

The cen­tral bank chief, who stud­ied at the Univer­sity of Bern and at­tended Har­vard, is very aware of the con­tin­u­ing bat­tle he faces. He cites ev­ery­thing from weak­en­ing in the economies of China and Brazil to the price of oil and even Bri­tain’s ref­er­en­dum on Euro­pean Union mem­ber­ship as po­ten­tial sources of trou­ble. Al­though it’s still much lower than in neigh­bor­ing France or Italy, the job­less rate rose through­out 2015, to a five-year high of 3.4 per­cent in De­cem­ber; that month, there were nearly 8 per­cent more job seek­ers than at the end of 2014.

The strong franc also damp­ens price pres­sures by mak­ing im­ports cheaper. Con­sumer prices tum­bled 1.1 per­cent last year, the most since 1950. Jor­dan says the neg­a­tive de­posit rate, still at 0.75 per­cent, and the SNB’s proven will­ing­ness to sell francs even af­ter re­mov­ing the cap will help weaken the Swiss cur­rency over time. That can only help the econ­omy, as would health­ier growth in the euro re­gion. Says Jor­dan: “Given the dif­fi­cult sit­u­a­tion we’re in, the main fo­cus of the board is on mon­e­tary con­di­tions and to see how we can steer Switzer­land through this very, very stormy weather.”

The bot­tom line A year ago econ­o­mists were pre­dict­ing the worst af­ter Switzer­land scrapped the cur­rency cap. Now the econ­omy is grow­ing.


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