The SNB caused major market disruptions Thursday by suddenly abandoning the CHF/EUR cap, after still stressing its importance just 2 days prior. With the ECB heading for QE, after the EU’s top court Wednesday seemed to quieten legal concerns, it would have been increasingly difficult and costly to defend the cap and the central bank instead is opting for a further cut in interest rates to try and keep a lid on the franc.
Swiss Nation Bank Governor Jordan said in a press conference shortly after the shock announcement that the growing divergence between the monetary policies of the major currency areas have increased significantly, which led to a depreciation of the EUR against the USD and in turn a weakening of the CHF against the USD. He added that in these circumstances the SNB has concluded that enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified.
With Mario Draghi now pushing for sovereign bond QE, while markets speculate about Fed exit steps, the situation has changed and as Jordan highlighted, the depreciation of the single currency against the USD also had implications for CHF as long as the currency cap was in place. It has been highlighted that the world’s biggest oil trading intermediaries sit in Switzerland and have been taking advantage of the currency cap by swapping what little USD they still get amid the falling oil price into EUR before converting them back into CHF.
The other problem the central bank has is that the further cut in interest rates not only has an impact on stock markets and exchange rates. Negative rates may help to mitigate the deflationary impact of a stronger currency, but the risk is that it further fosters the real estate bubble and lead to an accumulation of financial risks at Switzerland’s banks, especially those focused on the domestic market, on the other. This will call for an even closer watch of risks and may require an adjustment of capital in the future.