The Swiss National Bank launched new measures on Wednesday to fight a surge in the franc that is strangling the export-dependent economy but will probably have to resort to more drastic steps as investors seek a safe haven from global woes.
The SNB said it would significantly boost franc supply in coming days including by conducting foreign exchange swap transactions, but it stopped short of direct intervention after its currency market forays ran up record losses last year.
The franc, which soared over 5 percent to almost reach parity with the euro amid a market rout on Tuesday, fell slightly after the SNB announcement, but later resumed its climb, trading up 0.3 percent at 1.0387 per euro at 4:10 a.m. EDT.
Market players said anything other than direct intervention by the central bank or the introduction of some kind of capital controls was unlikely to succeed in stemming further gains in the franc, seen as one of the few remaining safe havens.
We think the SNB will continue to fight the rise of the franc in this manner, but the market will fight it too, said Tony Nyman of Informa Global Markets.
It seems they want a parity test in euro-Swiss franc. With or without intervention the franc remains the safe haven of choice for FX investors.
Investors have long flocked to the franc during times of financial crisis due to Switzerland's political stability, the country's neutrality, low levels of government debt and a healthy current account surplus.
But its popularity has been amplified of late as the appeal of the dollar has diminished amid a sluggish U.S. recovery and following Standard & Poor's downgrade of the United States' credit rating from triple-A.
Since world markets went into a tail spin in July over the escalating euro zone debt crisis and wrangling to avert a U.S. government default, the franc's rise has accelerated, jumping 17 percent against the euro and 16 percent against the dollar.
EXPORTS UNDER THREAT
Swiss exporters have called on both the SNB and the government to take action although the central bank is seen as wary of intervening after coming under heavy fire for losses it incurred in post-crisis interventions in 2009 and 2010.
SNB Chairman Philipp Hildebrand, who has faced calls to resign over those losses, said last week the franc was exerting an extreme disinflationary effect and risked significantly slowing economic growth in the second half of the year.
Swiss exports of goods from watches to drugs to financial services have held up remarkably well given the strength of the franc since the crisis, but companies have started to report a big impact on earnings in recent months.
The SNB announced a shock cut in interest rates to as close as possible to zero a week ago but the impact on the franc was short-lived and it soon resumed its climb as global stock markets tumbled following Friday's S&P downgrade of U.S. debt.
However, the SNB's drive to boost liquidity in the money market in an attempt to make holding francs less attractive has prompted yields on short-term Swiss paper to turn negative.
The franc jumped close to parity with the euro late on Tuesday, hitting a new record high of 1.0075 francs per euro as well as a new peak against the dollar of 0.7068, according to dealing platform EBS.
BACK TO THE 1970s?
With this exchange rate it's almost impossible for Swiss exporting companies to remain competitive, so some action was needed, said Sarasin analyst Ursina Kubli.
The SNB is clearly hesitant to act on the demand side after the unsuccessful intervention that ended in 2010, but on the other hand they may opt for negative interest rates as a further measure.
Switzerland imposed negative interest rates in the 1970s when the franc was surging as a result of the oil crisis, although the move had little impact then and would be hard to implement now given the openness of the economy.
A broader negative interest rate could work, Nomura analysts wrote in a note. One significant risk associated with this option is the impact on the Swiss banking sector.
The Swiss government last month rejected imposing capital controls or exporter tax breaks to help the economy, but said on Monday it was looking at new unspecified measures after an emergency meeting on the franc.
The SNB said it would keep a close watch on developments on the currency markets and take further measures if necessary.
The substantial rise in risk aversion on the international financial markets has further intensified the overvaluation of the Swiss franc in the last few days, the SNB said.
The massive overvaluation of the Swiss franc poses a threat to the development of the economy in Switzerland and has further increased the downside risks to price stability.
(Additional reporting by Martin de Sa'Pinto, Caroline Copley and Silke Koltrowitz; Editing by Catherine Evans)