Markets: The Swiss franc cannot fall “naturally”

Economic outlook - 4/11/2016

- The SNB has taken over the job of investing abroad from Swiss companies. - As long as that is the case, the franc will not be able to weaken sustainably.

The Swiss franc suddenly lost ground against the euro in January. By 4 February the EUR/CHF rate reached 1.1200, its highest level since the Swiss National Bank (SNB) scrapped its euro/franc floor rate on 15 January 2015. Now it has come back down to 1.0873 (see chart below


A number of factors would argue for a weaker franc, the first being that it is already grossly overvalued. In terms of purchasing power parity (PPP), for example, its fair value against the euro would be about 1.30. So by that measure, the franc's depreciation in January is easy to justify. Yet other forces are keeping the Swiss currency high and could push it higher still. They include Switzerland's positive current-account balance, the franc's real interest rate differentials, its safe-haven status, the risk of Brexit in the UK and currency speculation.


Besides the uneasy balance between these variables, we would like to emphasise another key point: the Swiss franc does not fall "naturally". When it weakens from time to time, as it did in January, this is because the central bank is at work behind the scenes. It lowered its deposit rate to -0.75% a bit over a year ago and continues to intervene massively in the forex market. Since the onset of the 2008 financial crisis the SNB has taken over the job of investing abroad from Swiss exporters, who have stopped doing so (see chart below). It has exported capital by buying foreign currency with francs.



So far this year the SNB has already added some CHF 16 billion to its assets. This is revealed in the constantly rising value of sight deposits, indicating that the movement is not over.


Clearly the Swiss franc is unable to weaken "naturally". The SNB does what it can but cannot work miracles. This situation is reinforced by current economic, political and financial conditions. In the coming quarters the EUR/CHF exchange rate will likely go on ranging between 1.02 and 1.12. Swiss francs are worth holding onto. 

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