Will the SNB surprise the markets?

After a month of dramatic developments in the currency markets, the Swiss National Bank (SNB) will hold its quarterly policy meeting on Thursday 15 December at 08:30 GMT.

Slow Growth

A strong franc continues to create problems for Switzerland’s economy by causing a slowdown in growth. Gross Domestic Product in the third quarter rose by just 0.2% at a time when the global economic conditions appeared to be deteriorating. The situation in the eurozone does not seem to be improving while investors argue for a mild recession and that uncertainty in the financial markets is affecting the Swiss economy.

Switzerland’s exporters have put pressure on the SNB to intervene and curb the strength of the franc. Swiss export growth is forecast to slow next year while economists expect a contraction in sales abroad as demand from European customers will be lower. Economic data also points to a slower growth with the KOF measure falling significantly. Retail sales and the jobs market also continue to be struggling with the unemployment rate remaining at 3%.

Deflation pressures

The Consumer Price Index in October assured investors that price pressures continue to be pushed to the downside after a 0.5% drop from a year earlier, making it the biggest drop in more than two years. The figures raise speculation that the SNB may need to act again to prevent deflationary forces from creeping into the Swiss economy.

Raising the ceiling

On 6 September, the SNB announced it would raise the exchange rate floor of the euro versus the Swiss franc to 1.2000 surprising the currency markets. The franc, which is considered a safe haven in times of uncertainty and risk aversion, gained against the single currency until the SNB imposed the cap. The SNB had a record loss of $21 billion in 2010 after it purchased foreign currencies at an unprecedented pace in the 15 months through June to stem franc gains.

One scenario for this week’s policy meeting is that the SNB could raise the EURCHF floor to 1.2500 or even as high as 1.3000. Another scenario is that the SNB may apply negative interest rates to foreign deposits to weaken the franc. But is it a wise decision to defend a higher floor for EURCHF while the eurozone debt crisis deepens? The scenario whereby the SNB decides not to move the exchange rate floor is also possible and, in such a case, the EURCHF may sharply drop and trade around 1.20.

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