Swiss franc conundrum exhausts policy toolbox

One topic currently dominates Swiss financial circles: Having abandoned its efforts to prevent the franc from appreciating beyond 1.20 to the euro, what does the Swiss central bank have left in its toolbox to prevent an economy-crushing drift towards parity for its currency?

The big worry in the financial community is that the franc is a one-way bet in the direction that will trash the country's exports. The Greek drama in the euro zone, combined with the global currency war among countries seeking to devalue their way to greater prosperity, amplifies the Swiss currency's haven status. And there might be nothing the Swiss National Bank (SNB) can do to halt an appreciation that has made the franc the world's best-performing currency against the US dollar by far this year.

SNB president Thomas Jordan, who has called the Swiss currency "markedly" overvalued, said his traders intervened to sell francs this week, trying to arrest its ascent as worries about Greece worsened. But having conceded defeat once, it's hard to see the monetary authorities winning this time around. And with the benchmark central bank interest rate already at minus 0.75 per cent, there's little scope for further rate cuts to deter people from owning the currency.

Here's a reminder of the violence of the franc's Jan 15 move, which came just days after central bank officials assured the world that capping the currency would remain the mainstay of monetary policy. Abandoning the defence - which had been in place since September 2011, with the central bank intervening to sell its own currency whenever it threatened to breach 1.20 per euro - spurred an unheard-of 30 per cent gain against the currencies of the Group of 10 industrialised nations.

The consequences have been dire. The franc's jump destroyed exports by making made-in-Switzerland products more expensive; exports of goods slumped 2.3 per cent in the first quarter. The economy shrank by 0.2 per cent in the first quarter this year, its worst performance in six years. And the second quarter will probably see Switzerland slide into recession; a further contraction of 0.2 per cent in gross domestic product is anticipated by economists in a Bloomberg survey.

The Swiss National Bank in Bern. There might be nothing the central bank can do to halt an appreciation of the franc that has made it the best-performing currency against the US dollar so far this year. PHOTO: BLOOMBERG

And, of course, whenever you see the words "Swiss exports", naturally your thoughts turn to horology; sales of Rolexes and other watches account for more than 10 per cent of the country's exports. But in May, shipments of timepieces dropped 8.9 per cent, said the Federation of the Swiss Watch Industry, the biggest decline since November 2009.

The correlation between watch exports and GDP is not that strong. From June 2006 to the first quarter this year, the relationship has been  about 0.15 per cent, where 1 per cent would suggest the pair

moving in lockstep while zero would indicate no mathematical coupling. Moreover, as my colleague Leonid Bershidsky wrote last month, declining exports can be explained by the crackdown on corruption in China, which has annihilated demand for glitzy timepiece bribes, and the fact that May 2014 had two more working days than May 2015.

But there's another aspect of global trade that's rattling Swiss financiers. A new trade deal between the European Union and the United States - the proposed Transatlantic Trade and Investment Partnership, or TTIP for short - could wipe as much as 0.5 per cent off Swiss GDP, a study by the World Trade Institute showed. If the European Free Trade Association, which includes Iceland, Liechtenstein, Norway and Switzerland, joins TTIP, on the other hand, Switzerland could boost GDP by as much as 2.9 per cent, the study suggested.

Swiss International Air Lines' CEO Harry Hohmeister this week said he expects the Swiss Parliament to put up "massive" opposition to joining the trade deal. That would be a mistake.

With the Swiss central bank effectively powerless to steer the value of its currency to the advantage of exporters, and with a recession looming, Switzerland needs to adjust to the new reality. BLOOMBERG VIEW

A version of this article appeared in the print edition of The Straits Times on July 04, 2015, with the headline 'Swiss franc conundrum exhausts policy toolbox'. Print Edition | Subscribe