Strategy Bulletin  

20/06/2014

WILL THE SNB HAVE TO FOLLOW THE ECB?

Now that the ECB has finally come up with a reflation program, the question of the SNB’s ability to hold its 1.20 floor with the EUR is back in focus again. Whilst the EUR has started to weaken (albeit mostly versus the USD), the SNB just decided to keep its monetary policy unchanged. We think it will not necessarily have to intervene going forward to hold the floor.

First, the ECB’s action takes place in a context of slowly healing economies, muted systemic risk and investors high risk appetite. It should therefore induce investors to favor risky assets rather than safe havens. Second, as recent episodes of volatility suggest, triggering little to no FX interventions by the SNB (see Chart 1), unless we see a return of systemic risk (not our scenario), safe haven flows into the CHF should stay limited. Third, the SNB’s FX policy is credible by now, limiting the risk of a speculative attack. Should the SNB nonetheless come under pressure, it would both have the leeway (albeit not unlimited) and the means to intervene. Inflation is well below target and inflationary pressures are muted (see Chart 2). Housing, whilst still overvalued, is cooling (see Chart 3), a sign that tighter government regulation on mortgage loans starts to bite. And whilst the size of the SNB’s balance sheet is frightening (82% of GDP, versus 25 to 40% for other major developed central banks), there is no theoretical limit to its expansion. Provided it counters the side-effects of its policies on housing, the SNB thus still has the leeway to defend its currency floor.

The SNB would have four options to intervene. First and foremost, do unsterilized interventions on FX markets (i.e. by printing CHF to buy EUR), as it did in the past. To prevent liquidity from flowing into mortgage loans, it could ask the government to tighten mortgage regulation further. FX interventions are easier to unwind than a rate cut, at least in a normalized environment (the SNB has not managed to reduce its FX reserves so far). Second, the SNB could apply negative interest rates on non-residents CHF deposits (as it did in the 70s). With a EUR/CHF at 1.22 and a floor at 1.20, a mere 2% tax would be sufficient to annihilate expected currency gains (unless investors bet on the floor to break). One caveat: investors could circumvent the tax by investing in CHF-denominated equities or bonds – with the risk, though, of being exposed to the underlying asset. A third option would be to narrow the SNB’s target range (as the 3-month LIBOR rate is already at 0%) from its current 0 and 0.25% band. Effectiveness of such a measure would be limited, unless combined with FX interventions. It would also risk spurring a housing bubble through lower mortgage rates. Finally, it would be more difficult to unwind as any rise in the target rate and/or widening in the range would be perceived by investors as a tightening, with the risk of pushing the CHF higher and challenging the SNB’s floor policy. The last option would be, under the extreme case of a speculative attack against the SNB, to raise the floor to e.g. 1.25 in a move to cut speculators short. Such action would be highly risky as it could fail whilst blowing the SNB’s balance sheet to new highs.

In all, we think the SNB will not necessarily have to intervene as a result of recent ECB action. Should the CHF come under pressure again, it has the leeway and the means to defend its policy. We therefore think the floor should hold, and expect the CHF to stay close to current levels in the medium term.

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