Highlights

  • Swiss National Bank embarks on quantitative easing measures

  • SNB intervenes to stop the franc appreciating

  • Forint and other eastern European currencies stage a recovery


Things can always get worse

The euro has strengthened significantly this week, gaining over two US cents to well over 1.29. This was not so much the result of a fundamental improvement in the currency itself, quite the contrary in fact: in view of the current economic data, particularly those from Germany, we are revising our 2009 growth forecasts for Germany and the eurozone down sharply. Last week, the ECB governing council appeared to have reached a more realistic assessment of the economic risks, but this week brought contradictory signals from some representatives. At any rate, there seems to be a strong faction in the council which is of the opinion that the ECB’s scope is virtually exhausted. The euro, however, was boosted primarily by the equity market recovery, the Swiss National Bank’s intervention and the fact that financial markets in eastern Europe have calmed down.

EMU: GDP collapse is accelerating

Current German foreign trade and industrial production figures show that the slump in economic activity in the first quarter has intensified. If industrial production were to remain at the January level for the rest of the quarter (which is by no means certain), production would plunge by over 11% compared with the previous quarter. In Q4, the drop in production was “only” 6.6%. Foreign trade is following the same pattern; in Q1, exports’ contribution fell by well over 10%. In January, industrial new orders from abroad were about 19% below the average for the fourth quarquarter. Against this backdrop, real GDP could decline by around 4% quarter on quarter (not in annualised terms!), after a 2.1% drop in the fourth quarter. Even if the economy were to pick up again later in the year, economic activity could still drop by an annual average of around 7%. This reflects just how capital goods oriented and heavily reliant on exports the German economy is.

The downward revision for Germany will drag EMU growth down by about one percentage point. Furthermore, downward revisions seem to be on the cards in other European countries too.
In January, French industrial production fell by 3.1% month-on-month, and was thus 5% below the average for the fourth quarter. On Friday, BdF president Christian Noyer stated that growth in Q1 would turn out to be worse than the Banque de France had been expecting up to now. To put it briefly: the growth prospects in the eurozone appear to be a lot gloomier than the ECB had projected a week ago.

SNB: bold action against deflation

Following in the footsteps of the Fed, the Bank of Japan and the Bank of England, the Swiss National Bank has now embarked on quantitative easing. Due to the deflation risks and the increase in capital market risk premia which is hampering the transmission of monetary policy stimuli, the SNB lowered the three-month Libor target range from 0.50 to 0.25%. As rates for one-week refinancing operations have been 0.05% since December as it is, the classical methods of influencing the money market are more or less exhausted. The SNB has therefore announced, that it will increase liquidity substantially in order to bring the three-month rate down to the target rate. To this end, it will engage in additional repo operations, buy Swiss franc bonds issued by private sector borrowers and purchase foreign currency.

Like the Fed, the SNB is now also trying to exert direct influence on financing conditions for private sector borrowers by buying private bonds on the open market. The foreign exchange dimension is peculiar to Switzerland, however. The SNB states explicitly that it wants to prevent the Swiss franc from appreciating further against the euro. The SNB has now actually confirmed that, immediately after the monetary policy decision had been announced, it had intervened in the currency market to weaken the franc. Subsequently, EUR-CHF rose from 1.48 to 1.53.

One positive side-effect of the Swiss measures is that they helped to calm down eastern European financial markets. Some eastern European countries are in a sticky situation mainly because of extensive foreign currency-denominated financing. Loans in Swiss francs were particularly in demand because of the low interest rates. SNB rate cuts and measures to prevent the franc from appreciating thus also reduce financial market risks in eastern Europe.

Since the beginning of this week, the Hungarian National Bank has been issuing official statements and also, reportedly, intervening in the forex market, in an attempt to strengthen the forint. The measures implemented by the SNB gave the Hungarian National Bank’s efforts an additional boost, thus enabling the forint to firm significantly. EUR-HUF fell from 316 at the end of last week to around 295 currently.