Global Trends and Politics

“SNB's action will dampen economic growth in Switzerland”

Even the Swiss themselves were taken unawares by the end of the exchange-rate cap against the euro, which has shaken confidence worldwide. Topics Online talked to Michael Menhart, Chief Economist at Munich Re, about the background and consequences.


Switzerland's central bank has ended the 1.20 Swiss franc cap against the euro – which took the markets by surprise. Why did they do it?

The aim of the cap had been to protect Switzerland's exports by preventing the appreciation of the Swiss franc. To do this, the central bank had been buying euros heavily since September 2011 – mostly in the form of German government bonds. The effectively fixed exchange rate resulted in the Swiss National Bank (SNB) being bound to the ECB's monetary policy. It is highly likely that the ECB will soon be buying up large amounts of government bonds, which would have obliged the SNB to significantly expand its balance sheet again and intervene massively in the foreign-exchange markets in order to maintain the peg. As the SNB's balance sheet was already inflated, it gave up the link to the euro. As the head of the Swiss central bank said, the step was intentionally taken without warning to prevent the speculation and insider trading that would have followed any prior announcement.

Will this tend to strengthen Switzerland as a financial centre and put the euro under more pressure?

First of all, the SNB's action could have a major adverse economic impact on Switzerland as a location. With the Swiss franc close to parity to the euro, Swiss exporters will in the short term find it difficult to compete on price internationally, and the tourism sector will have a fight on its hands. The immediate adverse effect on exports of the SNB's action will dampen economic growth in Switzerland. Combined with the large drop in the oil price last year, the strong appreciation of the Swiss franc also risks causing deflation in Switzerland, which could have further negative implications for the real economy. The stock exchange has already reacted to the resultant gloomy prospects for Swiss companies, with the Swiss SMI index at one time down as much as much as 14 percent yesterday after the measure had been announced. The scrapping of the link to the euro may increase demand for the Swiss currency, which will now be even more sought after as a safe haven. Apart from the rise in demand in the foreign exchange markets, more foreign money is now likely to start flowing into Switzerland. What isn't yet clear is what consequences the SNB's action will have for institutions outside Switzerland and what upheavals it could cause.

You mentioned the imminent decision of the ECB to buy up government bonds. What is your view on the measure, and do you think it will have any effect?

The decision hasn't been taken yet – we'll have to wait until 22 January, but anything other than a decision to go ahead would be a surprise. I would consider such a decision to be wrong. For a start, opinions on how serious the risks of deflation are can vary. In particular, I don't think buying government bonds is the right way to counter the risks of deflation in Europe. The possible side effects are enormous. The risks would be huge, for example we could see asset price bubbles, and both savers and long-term investors would suffer. And – not least importantly – the pressure on crisis-hit countries to introduce long-term reforms to consolidate their finances would decrease. The ECB's actions must of course be primarily aimed at achieving its main objective – price stability – even if there are risks and side effects. However, in this case, the ECB is creating large risks by using an instrument that may not have the desired effect on inflation at all. And it will then have little else left in its armoury.

So are we heading for uncertain times in the foreign exchange markets?

Like the economic situations in the various parts of the world, monetary policies are moving in very different directions. Whilst in the USA and Britain people have been talking for months about a rise in interest rates, the European Central Bank is sticking to its very lax monetary policy. However, this is not yet causing the types of upheaval we are now seeing in Switzerland, where the main factor has been the sudden and unexpected end of the exchange-rate cap. Central banks generally give warning of decisions with such far-reaching consequences. Nevertheless, there is a risk of a deflation spiral in the USA, Europe and Asia. The US dollar has appreciated considerably over the last few months, and the USA does not have a history of standing by watching the dollar rise indefinitely. At some point, it may remember its exporters and take action.