Raising exchange rate seen as risky strategy

Exporters would gain from weakening franc, but others could lose Keystone

The export sector and trade unions are placing pressure on the Swiss National Bank (SNB) to raise the exchange rate floor from SFr1.20 against the euro to SFr1.40.

Swiss Economics Minister Johann Schneider-Ammann has warned that the strong franc could cost 40,000 Swiss jobs. But some observers fear that raising the exchange rate ceiling could chain the central bank to potentially damaging consequences.

The euro has been in free fall against the franc since the financial crisis three years ago. Fears that the debt problems of some European countries could explode have fuelled an exodus away from the euro towards the safe haven franc.

In September, the franc virtually reached parity with the euro, forcing the SNB to set a minimum exchange rate of SFr1.20. The central bank’s insistence that it would print as much money as necessary to defend this target has so far worked.

But a string of recent high profile job cuts at prominent firms has led the State Secretariat for Economic Affairs (Seco) to calculate that the jobless rate could rise from 2.9 per cent to 3.7 per cent by the end of next year.

Theory versus practice

Exporters and unions say the SFr1.20 exchange rate has only dampened the fires, not snuffed them out. The franc is still overvalued, they say, forcing companies to save costs through job cuts with their goods still over-priced in the key European market.

Only with a floor of at least SFr1.40 against the euro can jobs be saved, critics of the SNB have argued.

“The SNB could set whatever exchange rate it wants because in theory it could print unlimited amounts of francs,” Manuel Ammann, director of the Swiss Banking and Finance Institute at St Gallen University, told swissinfo.ch.

Technically, any central bank could weaken its currency by flooding the market with freshly printed money and by buying up foreign reserves, according to Ammann.

Daniel Lampart, chief economist of the Swiss Trade Union Federation, believes the SNB has the strength to defeat any speculators buying up francs in the hope that the central bank would blink first and give up on its policy of holding the currency down.

Lampart believes the franc has a fair valuation of SFr1.50 against the euro. “An exchange rate of SFr1.40 would also leave the franc over-valued, but such a target would have a much better impact on the Swiss economy than SFr1.20,” he told swissinfo.ch.

Central bank mandate

Lampart argued that the SNB would be living up to its mandate with such a strong intervention. The SNB is supposed to guarantee stable prices and support economic stability, which could hardly be achieved without fighting against the over-valuation of the franc.

But financial expert Ammann warned against setting a SFr1.40 exchange floor, fearing such a move would entail an inflation threat and result in the central bank having to abandon all else in a single-minded defence of the target.

“The higher the central bank sets the target, the greater is the risk that it cannot unwind the position without feeling some pain,” Ammann warned.

Permanently linking the franc to the euro would bind Switzerland – for better or worse – to European Central Bank policy. Switzerland could wind up with a ballooning state debt to finance such a move and could furthermore run into the problem of rampant inflation, Ammann says.

The price for ramping up intervention could be massive losses in the currency markets leading to the technical bankruptcy of the SNB. “It is possible that the central bank would then have to be recapitalised to the tune of dozens of billions of francs,” Ammann added.

However, Lampart can see no such risks as long as the franc remains artificially high. “On the contrary, an over-valued franc could only lead to downward price pressure,” he said.

Winners and losers

Ammann insisted that no-one – not even the SNB – can know the proper and fair value of a currency. What seems a fair value today could seem over-valued in years to come, he argued.

With this in mind, Ammann also criticised the commonly-held view that a weakening franc could only bring winners and not losers.

“Weakening a currency always entails a rebalancing,” Ammann said. On the one hand, exporters would gain advantage as the price of their goods fell abroad, but investors and pensioners would suffer from the weakening of their purchasing power.

But Lampart countered that savers had also lost from the strengthening franc as the portion of investments and pension funds held in foreign shares and currencies also fell in value.

Safe haven franc

The Swiss franc is a so-called “safe haven” currency, which means that investors and speculators buy it when other currencies, including the euro and the dollar, are under pressure.  
 
The Swiss National Bank has emphasised that it does not pursue an exchange rate target, but consistently bases its monetary policy on its legal mandate. 
 
This mandate stipulates that “the SNB is required to ensure price stability, while taking due account of economic developments”. 
 
Starting in March 2009 the SNB intervened in currency markets. But after pumping in 15 per cent of GDP in May 2010 to little effect as the Swiss franc surged during the first round of the Greek debt crisis, it dropped the plan in June 2010. 
 
These forays led it to a loss of SFr21 billion last year, its biggest ever, and its chairman, Philipp Hildebrand, has faced calls to resign.
 
Facing intense pressure from politicians and the export community, the SNB further intervened in the markets this year before announcing a floor exchange rate of SFr1.20 against the euro in September.  
 
Since then, the franc has hovered above that mark thanks to the SNB’s pledge to buy unlimited amounts of foreign reserves.

(Adapted from German by Matthew Allen)