The Swiss National Bank (SNB) on Tuesday set out to stall the “massive overvaluation” of the franc by setting a minimum exchange rate target of SFr1.20 to the euro.
The move on Tuesday morning shocked foreign exchange markets and had the desired effect. The franc fell 8.2% against the euro to SFr1.2015 and it lost 8.8% against the dollar to SFr0.8563.
"With today’s decision, the SNB sets foot on a challenging journey," Philipp Hildebrand, SNB chairman, said. "We have to accept the fact that the costs associated with it might be very high. At the same time, doing nothing would almost certainly inflict tremendous long-term damage on our economy. With today’s measure, the Swiss National Bank is acting in the interest of the country as a whole."
Economics minister Johann Schneider-Ammann, who a day earlier had called on the central bank to take action, said the government backed the measures.
“I’m extremely happy that they took this decision. I think it was the right moment to do so,” said Schneider-Ammann. He said it would help ease problems for firms and had a psychological impact. “It will bring back confidence and some optimism.”
“The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development,” the SNB said in a statement.
The SNB stated that it was prepared to buy foreign currency in unlimited quantities, adding that the franc was still high at SFr1.20 to the euro, but should continue to weaken over time.
The franc has risen 25% against major currencies in the past 4 years.
The last time the Swiss franc's value was limited in a similar manner was 1978, when its exchange rate against the German mark was lowered.
Economic historian Tobias Straumann told the swissinfo.ch, the Swiss information service, that there are strong parallels between that period and now. He added that the decisive signals sent out by the SNB on Tuesday could have the same effect as in 1978 when the franc depreciated by 20% against the German mark within three weeks.
"I think the chances of success are high because the market now has a clear statement of intent," he told swissinfo.ch. "The currency markets, exporters and importers are now in a better position to make future calculations."
The 1978 measures resulted in 7% inflation in the early 1980s. A repeat of these levels depends on how much money the SNB has to print to back its words - - and that depends on how much credibility the central bank has in the markets.
"If the markets believe that the SNB is really prepared to risk price
instability then they will not act against this target," Straumann said.
"The SNB would only have to print money if its exchange rate floor is challenged."
The Financial Times says that the central bank, which is in part privately owned, lost almost SFr20bn last year after fruitless interventions in the foreign exchange markets that left it holding massive quantities of euros and dollars, whose value steadily declined in Swiss franc terms.
The Swiss could alternatively impose a punitive tax on speculative inflows - - it wouldn't be too difficult to identify the major ones - - above trend deposits from multinationals and significant new inflows in the past 12 months.
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