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SNB Evolves Franc Cap Rationale as Crisis Risks Recede

Swiss National Bank President Thomas Jordan
Swiss National Bank President Thomas Jordan has continually stressed the risk of a debt crisis flare-up, saying on Sept. 2 in an interview with Berner Zeitung that he has no intention of giving up the cap. Photographer: Valentin Flauraud/Bloomberg

Swiss National Bank President Thomas Jordan is about to explain why he’s keeping the ceiling on the franc even if the crisis that justified it has receded.

Two years after the SNB implemented a cap of 1.20 per euro to protect Switzerland’s economy from deflation and recession amid the sovereign debt turmoil affecting its neighbors, Jordan will probably stress at tomorrow’s quarterly decision that the tool remains necessary even though such threats have diminished.

SNB officials this month reiterated the need for the measure that has prompted them to build up reserves equal to three quarters of economic output at a time of global friction on currency policies. When the central bank introduced the limit in 2011, the franc was close to parity with the euro and the 17-nation bloc was poised to enter a record recession. The currency has since weakened and the region returned to growth.

“The SNB’s original justification isn’t valid anymore,” said Oliver Adler, head of economic research for Credit Suisse in Zurich, who predicts the ceiling will stay in place until at least the end of 2014. “The risk of Switzerland slipping into deflation next year seems very low.”

Switzerland’s 21-month streak of falling prices came to a halt in June, the economy completed a year of growth in the second quarter and investor confidence hit a five-month high in September. Still, the franc remains more than 20 percent stronger than in September 2008, when Lehman Brothers Holdings Inc. collapsed and according to a gauge in the SNB’s monthly bulletin on the Swiss currency’s trade-weighted strength, the franc was overvalued by nearly 11 percent in July.

SNB Decision

Such considerations may color the SNB’s statement tomorrow, when it will leave its target for three-month franc Libor at zero, according to all 21 economists in a Bloomberg News survey. It also will maintain the franc ceiling, the survey shows. The announcement is due at 9:30 a.m. in Zurich.

The franc traded at 1.2371 against the euro at 2:14 p.m. local time today, little changed from yesterday. It stood at 92.64 centimes against the dollar.

“They’ll be very cautious in interpreting the outlook for Europe, and very cautious on the floor for some time,” said Paul Robson, a currency strategist at Royal Bank of Scotland Group Plc in London. “We may not see the acute stress levels that we’ve had in the past, but I think it would be unwise to extrapolate from a few good pieces of data that Europe is set to recover strongly.”

European Central Bank President Mario Draghi has repeatedly highlighted the fragility of a euro-area upswing, saying this month that the recovery “is only in its infancy.” Industrial output contracted more than economists forecast in July and European car sales slid in August to the least since records started in 1990.

Crisis Risks

Jordan has continually stressed the risk of a debt crisis flare-up, saying on Sept. 2 in an interview with Berner Zeitung that he has no intention of giving up the cap.

Even so, the SNB may raise its growth prediction tomorrow from a current outlook of between 1 percent and 1.5 percent, after the economy expanded 0.5 percent in the second quarter.

“The SNB will have to revise its current forecast up significantly,” said Alessandro Bee, an economist at Bank J. Safra Sarasin Ltd. in Zurich. “However, the SNB will point out that it expects gross domestic product growth to slow in the second half.”

Swiss GDP will expand 1.6 percent this year, according to the median of 27 forecasts in Bloomberg’s monthly survey of economists. Switzerland’s State Secretariat for Economic Affairs will publish its own predictions at 7:45 a.m. tomorrow.

Growth Outlook

Such a “growth outlook looks solid in a pan-European comparison, eventually keeping appreciation pressure on the franc,” according to Reto Huenerwadel, a senior economist at UBS AG in Zurich. With the economy expanding, “the argumentation of the Swiss National Bank is going to turn more closely to the deflation story,” he said.

The SNB currently sees consumer prices falling 0.3 percent this year and rising 0.2 percent next year, and 0.7 percent in 2015. That’s well below its 2 percent price stability threshold.

While the Swiss economy is outperforming other European countries, not all areas are faring so well. The industrial sector has contracted, with machinery-makers hit particularly hard. The banking sector is having to change the way it does business due to a tax evasion crackdown by foreign governments.

“We need to see a more consistent, sustainable and broadly based improvement in risk sentiment on top of the recent improvement in the economic outlook for the franc to start weakening more markedly,” said Nordea Chief Analyst Anders Svendsen. “Looking ahead, numerous event risks remain.”

Arsenal Exhausted

Looking back at the franc ceiling, Michael Cross, the Bank of England’s head of foreign exchange, told the TradeTech FX conference in London yesterday that the SNB’s actions followed the exhaustion of its arsenal.

“It was an unusual thing to do, but understandable given the circumstances,” he said. “They had tried pretty much everything before they did that in terms increasing domestic money supply, forcing rates negative and they’d gone through the textbook of what a central bank does to loosen monetary conditions and they’d pretty much reached the end of the road.”

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