Switzerland’s franc, the second-best performing major currency in the past six months, is gaining strength from Eastern European homeowners falling behind on their mortgages.
After surging to $847.4 billion in the five years ended September 2008 from $519.5 billion, bank claims denominated in francs dropped to $647.6 billion in the first quarter, according to the latest Bank for International Settlements data. The decline includes consumers from Poland to Hungary who borrowed franc-denominated loans to take advantage of some of the world’s lowest interest rates and are now repaying the debt after the currency’s rally boosted their charges.
The results are an appreciating franc and efforts by Eastern European governments to unwind the mortgages, which may add even more strength to the currency after it rose to a record last week against the dollar. The Swiss National Bank had tried for 15 months to weaken its legal tender to support exports as a sovereign debt crisis engulfed the region.
“The more the franc is appreciating, the more there’s pressure on credit takers to close their foreign-currency credit lines,” said Manuel Oliveri, a strategist in Zurich at UBS AG, the nation’s largest bank. “That would lead to currency inflows” further strengthening the currency, he said.
Franc-denominated mortgages in Poland fell 7 percentage points to 60 percent of the total in the year through June as the Swiss currency jumped 7.7 percent against the zloty, government data show. Overdue mortgages in Hungary climbed 83 percent from December 2008 through March, the nation’s financial regulator said Aug. 9. The BIS bank claims data was valued using a constant March 31 exchange rate.
“We haven’t seen growth in those sorts of loans for some time -- they were obviously one of those things that weighed on the franc and that has now gone away,” said Henrik Gullberg, a strategist in London at Deutsche Bank AG, ranked by Euromoney Institutional Investor Plc as the world’s biggest foreign- exchange trader.
Switzerland’s franc fell 7 percent in 2009, based on Bloomberg Correlation-Weighted Indexes that measure performance against baskets of currencies, as the SNB slashed interest rates to 0.25 percent from 2.75 percent in 2007.
Franc loans lured Eastern European consumers as a means to escape high domestic rates. Borrowing costs in Switzerland in 2008 were as much as 10.5 percentage points below those in Hungary, and 2.25 percentage points less than the euro region. The gaps have shrunk by about half since peaking two months after Lehman Brothers Holdings Inc. collapsed in September 2008.
Some Eastern Europe home buyers borrowed in francs and then converted the cash into their domestic currency, keeping the benefits of low Swiss rates. With households now shunning this method of financing, fewer francs are being exchanged for currencies such as forint and zloty, removing a buffer limiting franc strength. The zloty has depreciated 7.2 percent this year versus the franc and the forint weakened 13 percent.
“Emerging Europe had borrowed more in foreign currency by the third quarter of 2007 than has been appreciated,” the BIS wrote in its quarterly review published Sept. 5. “Swiss franc loans represented about 20 percent of foreign currency loans. Ironically, currency flexibility encouraged Swiss franc debt, which has proven painful to obligors.”
Hungary will ban the registration of foreign-currency mortgages, the government said June 8. Prime Minister Viktor Orban plans to convert the mortgages into forint and buy non-performing loans from banks, state news agency MTI reported Sept. 16, citing an interview with Economy Minister Gyorgy Matolcsy on television station TV2.
“This is not going to be fleeting,” said Derek Halpenny, European head of currency research at Bank of Tokyo-Mitsubishi UFJ Ltd. in London.
Switzerland’s currency appreciated to a record 97.80 centimes per dollar on Sept. 24, before ending the week up 2.7 percent at 98.31. It traded at 98.43 at 10:13 a.m. in New York. The franc climbed to an all-time high of 1.2766 per euro on Sept. 8, before trading at 1.3249 today. It has risen 4.7 percent in the past six months, second only to the yen’s 6.4 percent gain, according to Bloomberg Correlation-Weighted Currency Indexes.
Bank of Tokyo predicts the franc will strengthen to 1.20 against the euro by the third quarter of 2011, while Deutsche Bank’s Gullberg said it will rise past 1.25 per euro by year-end. The currency will finish 2010 at 1.32 per euro and be at 1.33 by next Sept. 30, the median of no fewer than 22 analyst forecasts compiled by Bloomberg at the end of last week showed.
The franc may be vulnerable should slowing growth push Swiss consumer prices lower. The currency tumbled 1.8 percent against the euro on Sept. 16, its biggest drop since May 19, after SNB policy makers, led by Philipp Hildebrand, held rates near zero and cut their inflation forecast, signaling they’re in no rush to raise borrowing costs.
“We’ve seen the SNB becoming far less hawkish, you could even argue they’ve turned quite dovish, and that’s had an impact,” said Ian Stannard, a senior currency strategist at BNP Paribas SA in London. “The change in the policy response is significant and is likely to see the pace of franc appreciation slow down.”
Investors traditionally buy the franc during times of economic turmoil as the nation’s trade surplus frees it from dependence on overseas capital. The surplus climbed to a record 2.89 billion francs ($2.94 billion) in July, the Federal Customs Office in Bern said on Aug. 19.
Fresh concern that the euro-region’s most-indebted nations will struggle to reduce their deficits and the potential for the Federal Reserve to print more dollars to safeguard the economic recovery will also keep the franc in demand, said Axel Merk, president and chief investment officer of Merk Investments LLC in Palo Alto, California.
Yields on Portugal’s bonds rose to records relative to benchmark German bunds Sept. 24 as Diario Economico reported budget talks broke down between the government and the opposition. Spreads on Ireland government debt also reached a record relative to bunds.
“There will be more crises down the road, and the franc will play an important role for a defensive and diversified portfolio,” said Merk, who oversees $500 million. “The SNB trying to fight that is irresponsible.”
The Swiss central bank signaled in June that it would stop intervening to weaken the franc, saying risks of a drop in consumer prices had “largely disappeared.” Two weeks ago it forecast a “marked” economic slowdown in the second half of the year. The median estimate of economists surveyed by Bloomberg is for growth of 2.05 percent this year, compared with 2.7 percent in the U.S. and 1.6 percent in the euro region.
The nation has become 15 percent more expensive for tourists from the euro region because of the franc’s rally, according to Juerg Schmid, the Zurich-based head of Switzerland Tourism marketing group. While the average cost of a room at a four-star hotel in Zurich climbed 0.4 percent to 290.23 francs in June from a year earlier, according to the Zurich Hotels Association, the increase is about 16 percent when converted into euros.