Despite abandoning currency peg, nothing much has changed in Switzerland

By Yashvardhan Bardoloi

The National Bank’s dramatic removal of the Swiss franc's peg to the Euro in 2015 has not hurt the country’s economy as much as feared

By Yashvardhan Bardoloi |

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The Swiss National Bank (SNB) made an unexpected policy change in 2015 that didn't seem to change much.

In January 2015, the Swiss National Bank (SNB) unexpectedly abandoned the Swiss franc’s exchange-rate peg to the Euro. The currency had, until then, been set at 1.20 francs to a Euro. The move rocked financial markets, and the value of the Swissie, as the franc is known, soared to the highest level in its trading history.

One analyst said the franc’s sudden appreciation was a “20-plus-standard-deviation” move. He noted that such an event should happen, statistically speaking, once in “many squillions of years”. Why did the SNB so dramatically abandon its currency peg in 2015? Why was the peg introduced in the first place? And, three years later, where does the bank stand today?

In 2011, as the European debt crisis deepened, the SNB implemented what is known as a currency peg: a commitment by the central bank of a country to ensure that the value of its currency does not appreciate (or depreciate) beyond a defined value of another currency. The SNB tied the franc’s value to that of the Euro, a reasonable decision given the country’s geographical proximity and trade links with the bloc.

The peg became necessary because investors, seeking a “safe haven” amid Europe’s economic conflagration, started selling Euros aggressively in favour of the Swiss franc, which was seen as a “secure” currency. Unsurprisingly, the Swiss saw the value of their currency rise dramatically. Switzerland, whose GDP includes some 70 per cent exports, saw its competitiveness decrease. The stronger franc made it more difficult for foreigners to buy Swiss products.

To drive down the value of the franc to a level more conducive to Swiss economic growth, the SNB set the printing presses whirring, using the newly minted currency to buy Euros. This was a twofold measure to devalue the franc against the Euro: it bolstered the demand for Euros while increasing the supply of francs.

There are various theories that seek to explain why the Swiss abandoned the currency peg, but why they actually did it is still not known. A lot of people in Switzerland were angered by the rate at which the bank was printing francs. Some said the increase in money supply could lead to excessive inflation. Those concerns were more rooted in a tradition of monetary conservatism than in the evidence: Switzerland’s inflation at the time was actually very low.

Another plausible reason was that the European Central Bank’s planned “quantitative easing” (QE) would make it increasingly difficult to maintain the peg. QE entails stimulating an economy through measures such as bond-buying programmes. This essentially means pumping money into the economy as assets are bought. The resulting flood of Euros would further devalue the already weak currency, making it even harder to prevent the relative appreciation of the franc.

While removing the peg, the SNB attempted to dampen the upward pressure on the franc by simultaneously slashing deposit rates to the extraordinary level of negative 0.75 per cent. Cutting interest rates on deposits held in a particular currency should, in theory, reduce investor interest in that currency, instead encouraging them to seek better returns in other currencies.

With negative interest rates, this is taken to an extreme: instead of being paid for keeping money in a currency, you have to pay for the privilege. However, the effect of the interest rate cut proved to be negligible.

Regardless of the SNB’s intentions, the currency manoeuvre raised many concerns. The immediate fallout was felt by foreign exchange (FX) brokers and FX trading desks. FXCM, an American retail brokerage offering leveraged foreign currency trading, suffered huge losses and required an emergency bailout. Deutsche Bank, Citigroup, and Barclays lost a combined US$400 million.

Many at the time said that the effects on the broader Swiss economy were far more worrying, especially as a result of a freely floating currency.

Propelled by tourism and exports, it was forecast to come under immense stress. Tourism, such as visits to Switzerland’s famed ski resorts, becomes much more costly with the steep rise in the franc’s value. The knock-on effect from a slowdown in these two critical sectors was likely to be a diminished growth rate, higher unemployment, and stagnant wages. This could cause deflation, further dragging down the economy, as consumers delayed spending in the anticipation of even lower prices in the future.

Ultimately, the SNB’s move to remove the peg did not see these dramatic predictions come to fruition. The decision did not quite put Switzerland on a path of deflation and economic stagnation. That said, this is largely because the SNB, despite removing the peg, never really gave up its commitment toward exerting downward pressure on the franc. It continued to maintain low interest rates and frequently intervened in currency markets, to the extent that Switzerland fulfils many of the criteria for being labelled a currency manipulator by the American Treasury. And the Swiss franc today trades at 1.16 to the Euro. Not much has changed, after all.

Edited by M. J. Premaratne