Political pressure means currency shockers
Let’s step back in time. As we all remember, on Jan. 15, a surprise decoupling from the euro peg caused the Swiss franc to rally up to 23%, an unprecedented move in the currency market. Why was the peg introduced and later removed?
The Swiss National Bank pegged the franc to the euro in Sept. 2011, in the very middle of the eurozone debt crisis. A few peripheral countries, whose debts had been downgraded to junk status, asked for bailouts and led investors to run from euros and move into the Swiss franc, a traditional safe haven. The SNB introduced a minimal exchange rate at CHF 1.20 per euro (0.83 euro per franc) in order to resist currency appreciation--the CHF had gained 28% since the beginning of the Global Financial Crisis. Although gradual appreciation is positive and reflects the strength of a given currency, sudden capital inflows and exchange rate fluctuations may be quite detrimental. Therefore the SNB began printing and selling francs to keep the currency from exceeding €0.83.
The peg worked quite well, but it was not without costs. The SNB expanded its balance sheet to 80% of GDP, and the foreign currency reserves doubled from around 250 billion to 500 billion francs. At one point the SNB was buying half of the new government debt issuance of the Eurozone. Thus, the SNB removed the peg due to concerns about the large expansion of the money supply. Not only did the monetary base expand but also broad money (Chart 1), which actually increased as it did in Ireland or Spain before the Global Financial Crisis.
According to the SNB, 70% of the increase in the M3 money supply, which occurred between October 2008 and October 2014 (311 billion francs), can be attributed to the increase in domestic Swiss franc lending. Between 2011 and 2014 the bank’s lending rose from 145% to 170% of the GDP, which set off a property boom. Swiss real estate prices rose by an average of 6% per year between 2008 and 2013, and flat prices more than doubled since early 2007 until now. Consequently, the real estate bubble index published by the UBS found itself in the ‘risk zone’. Thus, the SNB’s move could have resulted from adopting a tighter monetary policy to avoid a further bubble and followed the housing collapse that crippled the economy in the early 1990s.
Perhaps the gold referendum in Nov. 2014 added some additional political pressure to tighten the monetary policy, while the expected announcement of the QE in the Eurozone on January 22 might be responsible for the timing of the SNB’s decision. Note that its move came just a day after the European Court of Justice paved the way for a program of sovereign bond buying. Additionally, as Thomas Jordan, the president of the SNB, pointed out, “The euro has depreciated substantially against the US dollar and this, in turn, has caused the Swiss franc to weaken against the US dollar.” For once, a reason for keeping the peg was removed.