Signs Switzerland may still face deflation risks mean its central bank could yet resume efforts to curb the Swiss franc's strength, but it is unlikely to step in unless the euro falls below 1.30 francs.
Swiss consumer price data on Tuesday showed only a limited pick-up in inflation in June. The Swiss National Bank last month cited subsiding deflation risks as a reason for ending its 15-month campaign to fight excessive franc rises.
An increase in deflation pressures, along with any threat to growth in Switzerland's export-driven economy and increased market volatility, could see the SNB resume intervention to weaken the franc, which hit a record high of 1.3070 per euro last week, analysts said.
The SNB must be wondering how to get out of this trap, said Elsa Lignos, currency strategist at RBC.
They can't rule out intervention as their mandate is price stability. I don't think they will be pushed to act on one data point but the CPI data does put deflation back on the table.
The euro EURCHF= traded around 1.3320 francs on Wednesday, holding much of its gains made during its short-covering rally in the past week or so which has helped the single currency to recover from its lifetime low.
The euro has tumbled around 4 percent versus the franc since the SNB dropped its intervention pledge on June 17, which was seen as a signal that the central bank was more comfortable with franc strength.
But SNB Chairman Philipp Hildebrand was quoted at the weekend as saying the bank was keeping a close eye on franc movements and analysts said this was a reminder that additional intervention cannot be ruled out.
The SNB has massively expanded its currency reserves since March 2009. Reserves have increased nearly fivefold since the central bank began its intervention campaign and totalled 225.8 billion francs in June.
SIGNS OF CONSOLIDATION
Many in the market suspect the euro must fall at least below 1.30 francs in volatile conditions for the SNB to consider resuming intervention.
(The June inflation) data may make the SNB more vigilant on Swissie strength, but since euro/Swiss has bounced, I don't expect any immediate reaction, said Karl Olsson, quantitative strategist at SEB in Stockholm.
But a euro fall under 1.30 may take longer than some in the market initially expected given the single currency's recent rally and as euro/Swiss implied volatility has subsided.
One-month implied volatility in euro/dollar EURCHF1MO= traded around 10.0 percent on Tuesday, according to Reuters data, pulling back from around 12.75 percent on Monday, its highest in more than a month.
Simon Smollett, options strategist at Credit Agricole, said he expected one-month implied vol to decline to 8.5-9.0 percent in coming weeks as trade in the pair calms down and consolidates around 1.30 francs.
The EUR/CHF options market seems to have calmed down, both on one-month implieds and ... risk reversals, so 1.30 francs is now being viewed as a temporary floor, he said.
Other analysts added that a fall under 1.30 may be volatile as it is seen as a key psychological level.
Neil Staines, chief operating officer at 3D Currency Management, said 1.30 would likely be littered with options barriers, which may exacerbate the euro's fall if it breaks through that level.
When we have seen moves through big levels, it's not strange to see a 200-point move so the SNB wouldn't be very comfortable seeing the euro at 1.28 very soon after 1.30, he said.
(Additional reporting by Lin Noueihed, editing by Nigel Stephenson)