Currency wars are here, argue Audrey Childe-Freeman and Cesar Perez of JPM Private Bank


At a time when prospects for the world economy have deteriorated significantly and with policy makers running out of ammunition, currency trends have become increasingly important. In fact, it may be argued that we have re-entered a ‘currency war zone' write Audrey Childe-Freeman and Cesar Perez (pictured)

SNB policy measures so far

   – Last year’s SNB attempt to address the Swiss franc strength failed to stabilize/reverse the currency and the SNB actually lost close to CHF20bn in the intervention process, raising questions as to the Bank’s credibility. The fact that the intervention process was actually publicly sterilized and came along with a sharp decline in monetary liquidity partly explains last year’s SNB failure.

   – In early August, the SNB has proceeded differently and has avoided directly intervening in the FX market. The monetary authorities opted to tackle the issue through the money market. There was a surprise rate cut on August 3rd (to 0%-0.25% from 0.0%- 0.75%), followed by a substantial increase (+150%) in money market liquidity. Banks’ sight deposits were increased from CHF 80bn to CHF 200bn in just two weeks.

   – More drastically, on September 6th, the SNB opted to announce a 1.20 ceiling on EUR/CHF. The SNB statement stipulates that ‘The current massive to the Swiss economy and carries the risk of a deflationary development.

The Swiss National Bank (SNB) is therefore aiming for a substantial and sustained weakening of the Swiss franc. With immediate effect, it will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF 1.20. The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities.

Even at a rate of CHF 1.20 per euro, the Swiss franc is still high and should continue to weaken over time. If the economic outlook and deflationary risks so require, the SNB will take further measures.’

Unlike in the 1978 ceiling experience, the September 6th policy statement did not indicate that this is a ‘temporary’ measure. This is arguably more aggressive and captures a central bank that i) not only wants to contain currency strength, but that ii) would also obviously also favour a change in trend. Furthermore, by insisting that it stands ready to ‘buy unlimited amounts of foreign currency’ the central bank has basically indicated that it envisages printing money indefinitely and accepts inflation as the price for keeping Swiss industries competitive.

Applying a ceiling on the Swiss franc: a lesson from the past

   – The ceiling option is not a first

The pegging concept is not new to Switzerland. Following failed attempts to weaken the Swiss franc through negative rates, the SNB introduced a temporary ‘ceiling’ for the value of the CHF versus the DEM (Deutsch Mark) in 1978. In October 1978, the SNB pledged to keep DEM/CHF substantially above 0.8000. The 1978 peg was a success in the sense that the CHF weakened significantly following the announcement.

The first month following the peg announcement saw a 5% CHF depreciation and overall, in the 18 months following the initial peg announcement, there was a 16.5% decline in the value of the currency. However, the price to pay was a substantial increase in inflation: from 0.8% y/y in September 2008 to 5% y/y the following year. This resulted from the interventionist FX policies and associated increases in money supply (in this instance, there was a 35% increase in base money supply in the year following the announcement).

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