Schweizerische NationalBank or, in English, The Swiss National Bank (SNB) has pulled a u-turn in policy; completely removing the upper cap placed on the Franc-Euro exchange rate during the height of the Eurozone crisis. The surprise announcement came last Thursday and sent shock-waves through foreign exchange markets.
Why Was There a Cap?
In 2011 the SNB set a minimum exchange rate of 1.2 Francs to the Euro to combat deflationary pressures and ensure a volatile Euro did not upset the Swiss economy. At the time there was lots of money piling into profitable Swiss assets. This increased demand for for Swiss Francs meant the value of the currency was going up and up. The cap was introduced to keep this rise in value under control.
But why would a country want a low currency value?
If the Swiss Franc – Euro exchange rate is low the Euro is worth a lot in terms of Swiss Francs. This makes it cheap for consumers in the Eurozone to buy from Switzerland ensuring that Switzlerland maintain a high volume of exports.
At the time of the cap there was some concern that it would be too difficult to maintain and could lead to high levels of inflation if the Euro was to fall in value dramatically.
So why did the SNB remove the cap?
Three and a half years on and the cap has become unsustainable. Last Thursday, the SNB announced they would no longer be operating an upper cap on the value of the Franc. This announcement led to a huge fall in the exchange rate with the Euro moving from 1.2 francs to 0.8 before recovering to 1.04 all in the space of a few hours.
Many Swiss figureheads have voiced concern at the affects of the change. Swatch CEO, Nick Hayek, described the move as a ‘tsunami’ for the Swiss economy. Mark Haefele, of UBS, estimates a cost to the Swiss exporter of 5bn Francs which amounts to a huge 0.7% of Swiss GDP (0.7% may seem a small number but when we are talking about losses of GDP, its colossal).
The SNB have tried to spin this in a way that protects their image but opinion around Europe is that their credibility is damaged. They have effectively thrown in the towel and given up. After three years of keeping their currency value low they have decided it is no longer sustainable with disastrous affects.
Earlier this month chairman of the SNB, Thomas Jordan, stated that the cap was ‘absolutely central’ and last Monday the vice-chairman of the SNB, Jean-Pierre Danthine, said the cap would remain the ‘cornerstone’ of SNB policy. Just three days later the SNB took a huge u-turn and abandoned the cap completely. Either the SNB were deliberately deceiving the market or they got things monumentally wrong and had no choice but to eat their words.
What does this mean for the Swiss Economy?
Watch out to see how Switzerland respond to the crisis. Swiss stocks have already lost over 100 billion Francs in value. Some companies have seen their shares fall by over 15% in price. Expect lots of cost cutting measures and outsourcing from Swiss companies trying to soften the blow of the shock.
Tourism is likely to take a hit. Switzerland is already an expensive place to go on holiday and will now be even more expensive. Switzerland is popular for ski holidays but high value services such as equipment hire and ski passes are where price increases will be felt the hardest. Many holidaymakers will opt for relatively cheaper locations such as Austria or France. Domestic tourism may also fall as Swiss tourists look to take advantage of their increased purchasing power and travel abroad.
Will anything good become of this news?
A few Swiss companies may benefit from the increased value of the Franc. Those who import raw materials will see the price of their imports fall and thus enjoy reductions in production costs. The same benefit will be felt by Swiss consumers who will see the purchasing power of their money increase when buying imports or travelling abroad.
There is speculation that the Swiss economy will fall into recession but Economists forecast that this will be avoided despite a large slowdown in growth. Expected growth for 2015 has been cut from 1.8% down to 0.5%. The World Economic Forum takes place in Swiss ski resort Davos over the next few days and will likely spawn much analysis on the state of the Swiss economy.