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The financial world is in disarray today. It all started with an unexpected and startling press release by the Swiss National Bank (SNB) that said:
“The Swiss National Bank (SNB) is discontinuing the minimum exchange rate of CHF 1.20 per euro. At the same time, it is lowering the interest rate on sight deposit account balances that exceed a given exemption threshold by 0.5 percentage points, to −0.75%. It is moving the target range for the three-month Libor further into negative territory, to between –1.25% an −0.25%, from the current range of between −0.75% and 0.25%.“
Within minutes of the SNB removing the peg, the euro dropped 30% from 1.2015 to 0.8422 as the currency reacted to the immediate impact of the blow. It is now 15 minutes past 4:00 p.m. and the euro appears to be stabilizing in the area of 1.04 versus the Swiss franc.
Meanwhile, the U.S. dollar, which had been gaining ground with the Swiss franc since late Spring 2014 and, having just reached par, suffered a similar collapse, dropping to 0.7187 from 1.0187. The USD has managed to climb back to nearly 0.91 where it seems to be, much like the euro, stabilizing.
The SNB, which, like the Bank of England and the Federal Reserve Bank in the U.S., conducts Switzerland’s monetary policy as a central bank, explain the overriding reason for its sudden change in policy:
“Recently, divergences between the monetary policies of the major currency areas have increased significantly – a trend that is likely to become even more pronounced. The euro has depreciated considerably against the US dollar and this, in turn, has caused the Swiss franc to weaken against the US dollar. In these circumstances, the SNB concluded that enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified.”
The bank explained that the policy of pegging to the euro at 1.20 had been “an exceptional and temporary measure” implemented in September 2011 to protect the Swiss economy. Whilst the SNB has both the right and authority to take this action, the reason that the rest of the world was caught unaware is that we all have a natural tendency to be lulled into thinking that a three-year-old temporary measure has become permanent, so it’s difficult to blame the SNB for the fact that the rest of us failed to see this coming.
As Luke Bartholomew of Aberdeen Asset Management noted, the SNB has a responsibility to protect the assets that are held in Swiss currency as a safe haven from exposure to the risks of being held on deposit elsewhere. There is also a valid position that says that the Swiss have made this move in anticipation of the ECB introducing quantitative easing as early as next week. The quantitative easing will effectively reduce the value of the euro. There is no point for the Swiss franc, therefore, to be devalued by continuing to be pegged to it.
The long-term implications of this move could lead to even more instability in the Swiss, European and world economies. For example, “an appreciation in the franc against the euro could hit the Swiss economy particularly hard as the country sends nearly half of its exports to the eurozone.” But the potential implications go far beyond that in scope.
While the FTSE indices all dropped dramatically until 11:00 a.m. UTC, each had recovered by 4:00 p.m. Meanwhile, in the U.S., the S&P, the Dow and the NASDAQ are each down by 0.46%, 0.33% and 0.75% respectively, with each showing some indication that they could recover before the day is over.
We will stay with this story as it continues to unfold.
