The Swiss central bank yesterday pledged to buy unlimited quantities of foreign currency to defend with “utmost determination” its cap on the franc’s exchange rate against the euro.
“The Swiss National Bank will enforce the minimum exchange rate of 1.20 franc per euro set on 6 September with the utmost determination. It is prepared to buy foreign currency in unlimited quantities,” the bank said in a statement.
“Even at a rate of 1.20 franc, the Swiss franc is still high and should continue to weaken over time,” the Swiss National Bank (SNB) said, adding that it would take further measures if necessary.
The central bank had put a floor on the euro’s value against the Swiss franc to shed its status as a safe-haven.
Amid the public debt turmoil engulfing the EU, investors have massively bought into the franc, sending it to record highs against the euro and threatening the alpine state’s export-led economy.
The central bank said yesterday that if not for its cap on the franc-euro exchange rate, “there would be a substantial threat of recession.”
For now, it is forecasting growth of 1.5 to 2 percent this year, slightly weaker than the 2 percent growth it predicted in June.
However, the Swiss bank’s move to cap the franc’s strength is complicating European Central Bank (ECB) efforts to contain the euro region’s debt crisis, depriving investors of a haven to hedge their risks when buying high-yielding bonds from the likes of Italy, Ireland and Portugal.
Meanwhile, an increase in the Swiss central bank’s purchase of “AAA” bonds from Germany and France to counter the franc’s gains may widen the yield difference with peripheral debt that the ECB has been fighting to narrow since May last year.
“The SNB’s move may potentially reduce demand for riskier assets such as high-yielding euro-denominated government bonds,” said Anthony Chung, a London-based director of research and currency strategies at AllianceBernstein LP. “In the past, some investors who bought riskier euro assets could hold the franc to mitigate downside risks, but nowadays, the franc can no longer be used as a safe-haven hedge.”
A decline in buyers of Italian and Spanish securities will put pressure on the ECB to buy more of these nations’ bonds and lower their borrowing costs amid deepening concern the debt crisis will spread to the euro region’s third and fourth-largest economies. The Frankfurt-based central bank began purchasing the two nations’ assets on Aug. 8.
Efforts to staunch the contagion may be imperiled if at the same time the SNB buys the safest euro-denominated assets.
“The widening of peripheral spreads implicit in the SNB’s support of the core is somewhat at odds with the ECB’s own intervention efforts, and by extension, will likely lead to a negative risk signal,” said Richard McGuire, a senior fixed income strategist at Rabobank International in London. “This, in turn, reinforces the fact that the SNB’s actions stand to prompt a widening of swap spreads.”
Concern that slowing economic growth will force investors to seek alternative safe assets has spurred more governments to signal their readiness to protect their currencies.
“Other safe havens are trying to close their doors too,” said Stuart Thomson, a portfolio manager at Ignis Asset Management in Glasgow.
The Bank of Japan intervened in currency markets on Aug. 4. Even so, the yen rose to a post-World War II record two weeks later. Brazil’s authorities have also sought to weaken the real.
Norway’s central bank stepped up its rhetoric to limit gains in the krone, which reached an eight-year high against the euro on Sept. 7 after the SNB’s policy move. Investors have also been drawn to the country’s budget surplus, which reached 10.5 percent of GDP product last year, the biggest of all “AAA” rated sovereigns.
“What the Swiss central bank does is going to make the ECB’s job much more difficult, especially if its policy intervention works,” Thomson said.
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