Swiss National Bank will maintain rates and EUR/CHF floor, Fed presents limited USD/CHF potential

FXstreet.com (London) - As the Federal Reserve moves to decrease its rate of monetary expansion, the risk flows that threatened to overheat the Swiss franc, damaging domestic exporters, have changed directions. But when the Swiss National Bank (SNB) announces its interest rate decision tomorrow morning, it will defend its policy of maintaining a CHF1.200 floor underneath the EUR/CHF rate.

It is now two years since the SNB first put the floor under the exchange rate. As volatility surged in the Eurozone with Spain, Greece, Italy and Portugal all in difficulty, investors flooded into the perceived safety of the Swiss franc. As haven flows overheated the currency, the then SNB chairman Philipp Hildebrand announced that the central bank was prepared to defend the currency, with unlimited selling of CHF.

But with global macroeconomic and volatility conditions vastly different to this time two years ago, why has the SNB chosen to continue the costly exercise of maintaining the EUR/CHF floor? The risk of Switzerland slipping into deflation is a small one and vastly outweighed by the capital reserves required to defend the currency.

Talking the down the currency

But comparing the effectiveness of SNB currency intervention to, for example, the Bank of Japan is a good lesson in the effectiveness of central bank communication to the markets. The SNB stepped in with a clear objective, a clear rational, and the cash in the bank to do so. The SNB knows that by keeping the floor in place, it communicates the SNB’s intentions to the market, it removes the need to defensively intervene in the currency whenever the CHF comes under threat. It is also worth noting that the franc currently sits at CHF1.2371, more than 20 percent above pre-Lehman levels.

Capital interventions are always economically damaging, requiring huge currency reserves. However, the SNB’s intervention has been lest damaging than most. And in light of Switzerland’s reliance on trade with the Eurozone, its control over CHF strength has bailed out exporters hurt by the exchange rate.

This desire to stave off inward flows will likely be reflected in the SNB’s statement tomorrow, where it will almost certainly leave three-month franc Libor rates at zero, having previously flirted with the idea of negative rates.

Any shift away from a contraction in the US Federal Reserves quantitative easing programme could drive some upside in USD/CHF this afternoon. But expect any upside to be limited and short lived.

USD/CHF currently stands at CHF0.9266.

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