Will the EURCHF 1.2 hold much longer?

All central bank(er)s have a soft spot for exchange rates. In most developed economies they leave this market alone. However, from time to time a certain level of the exchange rate is perceived by the authorities as dangerous for the economy. A level deemed too weak will threaten inflation and one deemed too strong will threaten growth.

I do not favor market interventions especially in the foreign exchange market. Central banks do have the power to control the market for some time but while they do “funny” things happen to the behavior of the market participants as the true market signal is distorted by the intervention. Basically the economy functions taking into account information that has been filtered: maybe the measured inflation is lower than it should have been or maybe the economic growth is perceived as higher than in reality and they spend more. In either case saving and investment decisions will be based on false or distorted information.

If the central banks will be able to commit that they will keep a certain exchange rate forever than my argument above is false as in the end the economy will adjust to this equilibrium. Unfortunately this is not true. Central banks, with very few exceptions, will only be able to control an exchange rate for a certain period of time. And with the end of the interventions cycle comes the adjustment towards where the level of the economy would have been in the absence of the central bank. Some times this process is very fast and painful and sometimes is smooth and it takes longer. The problem is that we do not know before hand on how the economy will respond without the central bank interventions.

Here is a concrete case: the EURCHF exchange rate.

The SNB decided that a level below 1.2 for the EURCHF will be harmful to the economy. To keep the rate there it had to increase the monetary base from 77 billion CHF to 252 billion CHF. This massive increase in the MB moved the exchange rate from 1.12 EURCHF to 1.23 EURCHF. But today, 4 months later, the EURCHF rate is at 1.2055 and the monetary base has decreased to 225 billion CHF. The question in from of us is: how long will the SNB keep pumping money to hold the EURCHF rate above 1.2? It does not look that they will hold this line much longer in my view. I think the SNB will in the near future announce either that it denounces the 1.2 level or that it will move that level a bit lower to 1.15 or 1.

In the same time one question still remains: How will they bring the monetary base back closer to the original level without appreciating the CHF or pushing the economy into recession?


6 thoughts on “Will the EURCHF 1.2 hold much longer?

  1. I do not think there is an urgency to diminish MB as most of the increase has no way to spill in to the economy and cause wide spread inflation. The only weay the Swiss can get inflation is to import it while keeping the 1.2 to a devaluing EUR which is depreciating more or less in tandem with the other curencies USD, GBP, JY, etc.

    By looking at the situation you can see the Swiss can ill afford any further curency increasses. The situation is even worst naw. The decision to place a limit on appreciation was not taken by will but by constraints, cnstraints which today are even stronger then a few monts ago.

    1. @i-conomics
      I was not worried about inflation. It is “much ado about nothing”. And the SNB has to think of an exit strategy. The longer it stays like this the harder it will be.

  2. Very good article. Also look at this: the ratio of long position to short position in EURCHF stands above 25. As there is no better contrarian indicator than FX retail traders, I think that something ugly might happen.

  3. In the race to the bottom of curency’s purchasing power, SNB has no real choice but to join in, otherwise the economy will breack down under the strain of an uncompetitive curency. I am not sure they worry about an exit strategy. More likly are woried about how to continue the current strategy without certain segments of their democratic society rebelling.

    By the way, did you notice the proposed referendum on gold repatriation plus requirement that 20% of SNB reservs be keept in gold? If this passes then watch out…. Whatis your stance on Gold?

  4. Tarile dezvoltate lasa pietele libere pentru ca le-ar trebui sume imense sa tina sau sa miste cursu cu cativa pipsi, nu ca n-ar vrea. Chiar si Japonia a incercat cu niste interventii, dar n-a tinut. La SNB vad ca tine deocamdata 1.20. Nu prin interventii directe in piata rezolvi problema. Plus ca orice interventie trebuie corelata cu mai multi indicatori macro, fluxuri, pozitiile bancilor, expuneri, consecinte interne etc. Oricum SNB a produs 13.5 mrde CHF profit in 2011 si a stabilizat economia dependenta de exporturi. Ma intreb care ar fi fost reactia la noi daca Isarescu ar fi facut o miscare de genul asta. Raspuns: ar fi sarit toti ca masluieste cursul. 😀

    1. @grasutu enigmatic
      SNB a stopat apreciarea deci fimele de export au avut de castigat, importatorii au fost “loviti”. Profiturile SNB vin de la importatori nu exportatori.
      Asa cum vad eu situatia nu pare un echilibru stabil. De aceea ma astept ori sa reduca din presiune prin reducerea tintei or flotare libea din nou. Si chiar si la ei se numeste masluire de curs, si cei de la BIS care au sediul in Basel au o multime de analize care sa le arate cat de nocive sunt interventiile valutare (mai ales cele directe).

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