EURCHF: after the SNB, what next?

The SNB’s surprise move has capped off an eventful week for the markets. The swissie had come under renewed pressure in recent days, but the SNB’s latest move has moved EURCHF out of the danger zone. Read our explainer below, to find out more.

What is the SNB doing?

In a surprise move, on Thursday the SNB announced that it was cutting interest rates into negative territory. The SNB’s 3-month libor target rate (basically, the interest rate) was cut to -0.25% from 0%, effective from 22nd Jan. This is a radical move, and no other major central banks have cut their main base rate to negative territory, the ECB cut the deposit rate into negative territory in June, it is at -0.2%.

A negative interest rate is designed to spur lending and spending, as there is a charge for keeping money in the bank. By flooding the economy with money you can also weaken the currency, which appears to be the SNB’s main motive for this move.

Why are they doing it?

From a fundamental perspective, cutting rates is justified to bring Switzerland out of deflation. Its annual rate of inflation is -0.1%, however this could fall further after producer and import prices slid 1.6% YoY last month. The SNB’s Jordan gave explicit reasons for the cut in rates:

• To weaken the Swissie.

• To overcome deflation.

• Top help spur growth, which is expected to be on the weak side in Q1.

While the internal factors justify the SNB’s actions, the timing of the move was surprising. The market had expected a move on rates sometime in January; however recent market volatility, and the sell-off in the rouble, threatened the 1.20 peg in EURCHF, which triggered this move.

Other external factors included the ECB and the Fed. The SNB has a close relationship with the ECB, and if the SNB found it necessary to hike rates now it could have been designed to precede a move by the ECB in January. In fact the negative rate will only come into effect on the 22nd January, which corresponds with the ECB’s next meeting. Thus, today’s move by the SNB suggests that the ECB may be getting close to QE, and since QE could weaken the EUR, the SNB had to act now to protect its EURCHF peg.

What does it mean for FX?

EURCHF surged on the news and remains nearly 50 points above the low from Wednesday. We think that this move should keep EURCHF safely out of the 1.20 danger zone for now, however in the longer term we think the SNB will need to embark on more action to stem CHF appreciation. Firstly, if this move by the SNB is a sign that QE is on its way from the ECB then we could see further downward pressure on the EUR. Secondly, downward pressure on the EUR could be compounded by last night’s fairly hawkish Fed, which may cap EURUSD gains.

If the EURCHF peg is pressured once again in the coming days and weeks then the SNB has said that it will defend the peg, as it is an important policy tool. If we see another move back below 1.2010 in EURCHF watch out, the SNB may buy EUR’s in size to get this pair out of the danger zone. Have your hard hats at the ready…

The race to the bottom

From a political standpoint, the SNB has a clear agenda to weaken the CHF. This seems to be the policy of choice for a number of other central banks including the Bank of Japan, and even the ECB can see the benefits of a lower currency. While this has been tolerated so far, what about the other central banks that are looking to normalise policy? Will they be happy to lose this race to the bottom? That is one of the major risks for next year. If the dollar continues to rise, will the Federal Reserve be happy to have the strongest currency in the G10. The SNB’s move could be a precursor to a currency war in the coming months.

Conclusions:

• The SNB cut interest rates into negative territory for the first time.

• While this is ostensibly to spur inflation and growth, it should also undermine the franc.

• The timing of the move surprised the market; however it seems to be in response to rising market volatility and the selloff in the ruble.

• Due to the close ties between the SNB and the ECB, the move may suggest that QE is on the cards for the ECB at its next meeting in January.

• Overall, this may protect the EURCHF peg for now, but the SNB may be compelled to intervene in the coming weeks if we get close to 1.20.