Jan. 26 (Bloomberg) -- Swiss central bankers are on a collision course with foreign-exchange traders, threatening to rein in the franc after the currency rose the most ever against the euro in 2008.

Credit Suisse Group AG predicts the franc will climb 2.6 percent this quarter. BNP Paribas SA, the most accurate currency forecaster in a 2007 Bloomberg survey, and Royal Bank of Scotland Group Plc say it will rise 4 percent by mid-year --even after Swiss National Bank Vice President Philipp Hildebrand said last week that policy makers may sell “unlimited amounts of francs” to curb the gains.

“The SNB on its own can’t stop it if the market wants to push” the franc higher, said Henrik Gullberg, a strategist in London at Deutsche Bank AG, the world’s largest currency trader. The central bank is probably sending “an early signal” and won’t intervene until the franc strengthens to about 1.4000 per euro, he said. Gullberg predicts 1.4650 by mid-year. The currency was last quoted at 1.5055 versus the euro, from 1.4962 on Jan. 23, and 1.1472 per dollar from 1.1542.

The franc surged 6.1 percent against the dollar and 10.8 percent versus the euro in 2008 as investors sought refuge from the global financial crisis. Switzerland has a trade surplus and doesn’t have to increase debt sales as much as other nations with a deficit. It’s also perceived as a haven from a global slump in equities, which pushed the MSCI World Index of stocks down a record 42 percent last year.

Welcome to Davos

Zurich-based SNB hasn’t intervened in foreign-exchange markets to influence prices by purchasing or selling currencies since the mid-1990s. The last time policy makers from one of the Group of 10 industrialized nations acted to weaken a currency was when the Bank of Japan sold 35.2 trillion yen ($390 billion) in 2003 and 2004. Instead of falling, the yen strengthened about 6 percent against the dollar in the year after sales ended.

Threats to intervene come as SNB President Jean-Pierre Roth prepares to welcome central bankers, political leaders and corporate chiefs to Davos, Switzerland, for discussions on reviving the global economy at the World Economic Forum Jan. 28- Feb. 1.

The worldwide downturn, triggered by a freezing of credit markets that resulted in writedowns and losses at financial companies totaling $1.05 trillion, forced central banks from the U.S. to New Zealand to reduce interest rates. That cut profits in half from so-called carry trades, where investors borrow in countries with low rates and invest in nations with higher borrowing costs, according to data compiled by Bloomberg.

Francs and Japanese yen were among the favorites for traders, who used the currencies to buy New Zealand and Australian dollars with interest rates as much as 7.75 percentage points higher.

Surplus Bonus

Switzerland’s trade surplus, at 8 percent of gross domestic product last year, was also a lure. The U.S., Australia and New Zealand had deficits of 4.9 percent, 5.1 percent and 9.5 percent, respectively, according to the Organization for Economic Cooperation and Development.

Trade-surplus countries are perceived as safer because governments don’t have to borrow as much money in a year when sovereign bond sales are likely to exceed $3 trillion.

The franc strengthened against every major currency except the yen in 2008 as investors reduced risks. Gold climbed 5.8 percent and Treasuries earned 8.9 percent, according to Merrill Lynch & Co.’s Treasury Master Index.

While the franc weakened 0.4 percent against the euro in January, last year’s gains were the most since Europe adopted the common currency in 1999. The 16-nation euro region accounts for more than 50 percent of Swiss exports, making it the country’s main trading partner.

Fighting Deflation

The franc’s rise prompted Hildebrand to say Jan. 21 that officials may intervene to bolster exports and head off deflation. Fellow policy maker Thomas Jordan said Jan. 15 the SNB has “no explicit pain threshold” on the franc as it watches the gains “very closely.”

“Deflation is just as undesirable as inflation,” Hildebrand said in St. Gallen, Switzerland. “In today’s environment, one could ask whether it wouldn’t be better to aim for a higher inflation rate in order to avoid deflation at any cost.” The central bank may set a fixed rate for the currency, he said.

Swiss inflation, which slowed to 0.7 percent last month, may turn negative as soon as the middle of this year as the currency strengthens, the central bank estimates.

A slump in exports, which make up more than half the economy, is being exacerbated by the currency’s gains. Sales abroad fell 11 percent in November and may drop 2.6 percent this year, the government said Dec. 16.

‘Big Problem’

Basel-based Straumann Holding AG, the world’s second-largest dental-implant maker, said Jan. 16 revenue dropped 3 percent in the fourth quarter because of the franc’s strength. On Jan. 20, Dierikon-based Komax Holding AG, the world’s biggest maker of wire-processing machines, blamed foreign-exchange fluctuations for a 2 percent decline in sales in 2008.

“A further appreciation of the Swiss franc against the euro is a big problem,” said Rudolf Minsch, chief economist at Economiesuisse, a Zurich-based business-lobby and industry group. “If you see a gradual appreciation during the course of months or years, then companies can adjust. But when the rate jumps sharply in a short time, companies can’t adjust.”

Swings in the franc more than doubled last year. An index of volatility peaked at 19.3 on Oct. 27, when the franc hit 1.44 per euro. The index was at 13.4 at the end of last week and averaged 8.1 over the past 12 months.

Risky Showdown

The franc is rising even as the credit crisis dents earnings at Switzerland’s two largest banks. UBS AG may post a 15.5 billion-franc ($13.4 billion) loss for last year, and Credit Suisse may report a net loss of 4.2 billion francs in the same period, according to analysts surveyed by Bloomberg.

A showdown with the SNB may be risky for franc bulls, said Zurich-based UBS, the world’s second-largest currency trader.

“Having a central bank against you can prove costly,” said Reto Huenerwadel, a senior economist in Zurich at UBS. Betting against the SNB is “brave to the degree of being foolhardy,” he said, and predicted the franc will weaken to 1.54 per euro by mid-year.

The SNB may not be able to revive the $416 billion economy just by weakening the franc, according to Claude Maurer, a Zurich-based economist at Credit Suisse.

“People are demanding stimulus programs,” Maurer said. Devaluing the franc “is a logical stimulus for the export industry, but it doesn’t do much when demand is weak.”

‘Double Whammy’

Switzerland’s economy will contract 0.2 percent this year after expanding 1.9 percent in 2008, the OECD said Nov. 25. The euro-region economy will shrink 0.6 percent, compared with 1 percent expansion in 2008, the OECD said.

Policy makers lowered the Swiss three-month London interbank offered rate, or Libor, target rate to 0.5 percent on Dec. 11, compared with 2 percent in the euro region, and a benchmark rate of 0.1 percent in Japan. The Federal Reserve maintains a range of zero to 0.25 percent.

“The SNB will be watching the euro-land economy,” said Paul Robson, a Royal Bank of Scotland foreign-exchange strategist in London. “Growth in euro-land is falling off really quickly. You don’t want the double whammy of falling external growth and a strong exchange rate.”

Investors are drawn to the franc in times of international tension and economic upheaval because of the country’s history of neutrality and political stability. The currency surged 3 percent in the 10 days after the Sept. 11, 2001, terrorist attacks on the U.S., and more than 1 percent immediately after the Madrid train- station bombings on March 11, 2004.

Bullish Investors

“The franc is always prone to strengthen in crises,” said Janwillem Acket, the chief economist at Bank Julius Baer in Zurich. “It’s going to lose some of its current strength as the crisis calms down.”

Trading in franc options as measured by the so-called risk- reversal rate, an indicator of foreign-exchange market sentiment, shows investors are more bullish on the franc against the euro than any currency except the yen over the next year.

“We’re likely to see further verbal intervention from the Swiss authorities,” said Ian Stannard, a currency strategist in London at BNP Paribas. “I wouldn’t be surprised if they started to step that up. The boy-who-cried-wolf syndrome is one risk. They have used verbal intervention on various occasions without following it up with physical intervention.”

‘More Upside’

The central bank cut its main interest rate four times since early October, reducing it to a four-year low. The franc gained more than 4 percent against the euro even after the rate was reduced to 0.5 percent on Dec. 11.

With rates already near zero, the SNB said it may buy government and corporate bonds or offer cheaper money for longer terms.

The euro fell in two of the past three weeks versus the franc amid concern governments in the 16-nation currency region will increase borrowing to records. Euro nations plan to sell about $1.1 trillion of debt in 2009, according to Royal Bank of Scotland. Switzerland plans to issue about 6 billion francs in bonds this year, compared with 5 billion francs in 2008, according to the SNB.

The yield on the benchmark 10-year Swiss bond is forecast to climb to 2.45 percent by mid-year, from 2.17 percent, while the cost of borrowing in the euro region, as measured by the German 10-year yield, will be 2.87 percent, down from 3.24 percent, according to Bloomberg surveys.

“We don’t think the franc’s status as a safe haven is under threat,” said Marcus Hettinger, head of foreign-exchange research in Zurich at Credit Suisse. “We expect more upside for the franc this year. The euro is overvalued.”

To contact the reporters on this story: Joshua Gallu in Zurich at jgallu@bloomberg.net; Matthew Brown in London at Mbrown42@bloomberg.net

Last Updated: January 26, 2009 09:44 EST