The Swiss franc has risen dramatically against the euro following the unexpected removal of the long-standing exchange-rate control by the Swiss National Bank (SNB). The cap - which was introduced in 2011 - was designed to prevent the Swiss currency from falling below 1.20 francs per euro in order to protect Swiss exporters.
The announcement on Thursday immediately sent the currency market into a flurry of panic, causing the Swiss franc to soar by around 37% in value against the euro at its peak. Whilst it has since leveled out, it still remains at around 30% of pre-removal value.
Whilst the move has made the average Swiss a bit richer overnight, the effects on the economy as a whole have not been positive. Swiss stock markets have been hit hard, plummeting by over 10%. A stronger currency also hits exporters, and Swiss companies selling goods abroad such as Nestle, Swatch and Roche may be forced to hike prices abroad. Meanwhile, imports will become cheaper, leading to fears of deflation hitting the Swiss economy.
The move by the SNB was largely unexpected, especially since its president Thomas Jordan declared only last month that he would "defend [the ceiling] with the utmost determination".
So why has the cap been removed?
According to Jennifer McKeown, chief economist at Capital Economics, the "upwards pressure" on the Swiss franc was "so great" that the SNB feared that if they did not remove the cap themselves, the cap "may be removed accidently anyway".
"They have abandoned the ceiling ahead of market pressure to allow the bank to essentially have more control over what happens," she said.
"I'm not sure however, that the SNB envisaged such a strong response," she continued.
Jeremy Cook, chief economist and head of currency strategy at World First, says that there are two main reasons why the cap was removed: the looming prospect of a major intervention by the European Central Bank (ECB), and the deteriorating economic situation in Russia.
"In the past six months the mood around the euro has changed quite dramatically," he said. "Next Thursday the ECB are almost unanimously expected to introduce quantitative easing in an attempt to lower the value of the euro", he continued, with QE referring to an asset purchase programme in which the central bank goes out into the market to buy bonds and debts in a bid to stimulate demand and encourage inflation within their country. This would also make their exports more attractive as the value of the euro falls.
He continued: "In order to maintain the 1.2 [franc exchange rate] against the euro, the SNB has to buy euros and sell Swiss francs to try and weaken the franc. They have a tsunami of euros coming their way, and so they have taken the decision to step out of the way because if they don't, they will get run over."
The second reason, he says, is the falling rouble, Western sanctions and declining oil prices in Russia.
"Russians have been parking money in Switzerland for a long time. But given the current economic situation, these flows have increased because of its stability and investors look on Switzerland as a 'safe-haven'. To put funds into Swiss banks they have created Swiss assets, which has then created a bubble in the economy," he said.
"In order to try and combat this, the SNB also decided to cut interest rates into negative territory [-0.75%] to discourage this, meaning that over time you actually have to pay to keep your money in Swiss banks."
"These factors have just made it uneconomical to maintain the cap at the moment," Cook continued.
In a statement yesterday, the SNB said the Swiss currency had now left an era of "exceptional overvaluation" during which the minimum exchange rate had been introduced.
It said: "The euro has depreciated considerably against the U.S. dollar and this, in turn, has caused the Swiss franc to weaken against the U.S. dollar. In these circumstances, the SNB concluded that enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified."
Whilst SNB chairman Thomas Jordan assured people that the decision to abandon the cap was not a "panic reaction", but rather a "well thought-out decision," according to Cook, the move is "vastly out of character" for any central bank.
"All central banks over the past few years have had a general policy of engagement to make sure that they all talk to the markets at all times and ensure that no steps are misguided and that there are no surprises," he said.
"This could not be more far removed from what happened yesterday. It was a mugging - it came out of nowhere. No wonder people are angry," he continued.
"In the short-term, I think it is quite a logical decision as they were going to get run over. In this sense it was a basic survival technique to step out of the way."
"However, if we don't re-introduce inflation, there are going to be disastrous consequences," he continued.
Uncommon Knowledge
Newsweek is committed to challenging conventional wisdom and finding connections in the search for common ground.
Newsweek is committed to challenging conventional wisdom and finding connections in the search for common ground.
