The Swiss central bank may have saved its economy by embracing Chinese-style currency policy.
Facing a franc surge that threatened to derail the economy, the Swiss National Bank has quadrupled its foreign-exchange holdings since March 2009 to slow the currency’s advance and protect exporters. China, holder of the world’s largest currency stockpiles, increased its reserves by 28 percent in that period.
While the SNB lost 14 billion francs ($13 billion) on currencies in the first half alone, the gamble is paying off. Foreign sales at Swatch Group AG and ABB Ltd., the biggest builder of electricity grids, are rising and manufacturing expanded at the fastest pace on record in July. The strength of the recovery may be such that the SNB can avoid buying more foreign reserves for now.
“Their policy was a success even if interventions reached extreme dimensions,” said Frankfurt-based David Kohl, deputy chief economist at Julius Baer Holding AG, a 120-year-old Swiss private bank. “It was a risk accumulating these holdings but ultimately it didn’t matter to them whether they’d suffer a loss.”
Investors traditionally snap up the franc along with commodities such as gold during times of crisis because of the perceived stability of the nation’s economy. As the collapse of Lehman Brothers Holdings Inc. in September 2008 roiled investors, the danger was that a jump in the franc would throttle exports, which account for about half of gross domestic product, and plunge the Alpine nation into deflation.
The SNB’s action helped limit the franc’s gain against the euro to 16 percent since then, compared with gold’s 59 percent advance in the same period. The central bank signaled in June that it’s ready to stop currency purchases.
The risk for the SNB is that any further rally in the franc and weakening in the economy forces it to wade more deeply into currency markets, putting it on a “kamikaze mission,” said Axel Merk, who oversees $500 million as president and chief investment officer at Merk Investments LLC.
“The power to print money, heavy foreign-currency exposure, may continue to create wide swings in earnings; we have already seen the SNB report losses as a result,” said Merk, who is based in Palo Alto, California. “We’d rather have the SNB focus on sound monetary policy than a cat-and-mouse game with speculators they are bound to lose.”
Hildebrand said on June 17 that surging reserves will “inevitably increase currency risk.”
The franc weakened against the euro for a third day today and was at 1.3765 against the single currency as of 9:25 a.m. in Zurich from 1.3749 yesterday.
The bank’s currency loss in the first half was equivalent to almost 5 percent of its balance sheet after it quadrupled foreign-exchange holdings to 226.7 billion francs ($219 billion) in the 15 months through June. China’s reserves were $2.45 trillion in June, International Monetary Fund data shows.
For now, the economy’s performance means the SNB has less immediate need to counter any renewed franc surge, says Dirk Schumacher, an economist at Goldman Sachs Group Inc. While the central bank has allowed the franc to appreciate 2.4 percent in the past two months, pushing it to a euro-era high of 1.3074 per euro on July 1, an index of leading indicators stayed at the highest in almost four years in July.
Swatch, which exports about 80 percent of its products, has risen 25 percent this year, while ABB gained 11 percent. The Swiss benchmark stock index has fallen 3.2 percent this year, less than the 5 percent drop by the Euro Stoxx 50 Index.
“There’s always a risk of renewed panic pushing the franc higher,” said Frankfurt-based Schumacher. “But as the economy grows stronger, there’s less of a risk of it hurting. The latest economic data show that the exchange rate is not a real stumbling block anymore.”
The SNB in June raised its 2010 growth forecast to about 2 percent, double the pace the European Central Bank projects for the euro region.
Nevertheless, the SNB’s action hasn’t been enough to help some companies. Hublot, the Swiss watch brand owned by LVMH Moet Hennessy Louis Vuitton SA, raised prices in the euro region on July 1 to counter the stronger franc and may increase them again in September, Chief Executive Officer Jean-Claude Biver said on July 6.
The SNB signalled it would end purchasing currencies at its June rate meeting, when policy makers said that deflation risks had “largely disappeared.”
The new quandary for the central bank is when to start raising borrowing costs. While keeping the benchmark interest rate at the current level of 0.25 percent for too long may spark domestic inflation, increasing it may make the franc more attractive to investors and hurt exporters.
“It’s what we call the SNB dilemma,” said Giovanni Staunovo, a currency analyst at UBS AG in Zurich, who expects the central bank to raise borrowing costs next month. “For the domestic economy, a rate increase would make sense but it could be problematic for exporters. In the end, it may depend on the exchange-rate development.”