The Swiss franc 2.0

President of the Swiss National Bank Thomas Jordan addresses the media
SNB President Thomas Jordan has said the bank would keep interest rates in negative territory, confirming that monetary policy would be a matter of discretion (source: dpa)

In periods of monetary uncertainty, investors have often flocked to the Swiss franc. They relied on history and were rewarded. For example, in August 2007 they needed almost 1.7 francs to buy one euro. Four years later, the exchange rate had dropped to 1.05 – the franc had strengthened by some 38 percent. After bouncing back to 1.20 in 2012-2014, in January 2015 the Swiss currency reached a record: 0.99 to the euro. The franc seemed unstoppable.

Understandably, those who had bet on Swiss prudence and wisdom had plenty of reason to rejoice. However, over the past two years, those who have left the euro and bought Swiss francs as a haven have had few opportunities to celebrate. Rather than confirming parity with the euro and speed south, the Swiss franc has weakened, and is now trading at about 1.13 francs to the euro. What happened?

No longer neutral

One might argue that nothing went wrong with the Swiss franc (CHF) and that the situation simply reflects the recent surge of the euro, rather than a drop in the franc. After all, if one considers the past five years (including the past 12 months), the USD/CHF exchange rate has remained stable. The same applies to the real effective exchange rate – the average exchange rate of the franc with respect to a bundle of significant currencies. Between 2011 and early 2017, the effective exchange rate of the franc remained almost unchanged, unlike the dollar (whose effective exchange rate appreciated) and the euro (whose effective exchange rate depreciated).

A stable exchange rate is not necessarily the consequence of neutral monetary policy

However, a stable exchange rate is not necessarily the consequence of neutral monetary policy. Indeed, the Swiss National Bank (SNB) has recently made it clear that it will no longer take a neutral stance. This explicit switch from monetary neutrality to growth-enhancing discretion is a crucial step. Let us examine what this means, and what scenarios could open up for the Swiss currency.

Discretionary policy

During the past decade, the SNB followed the United States Federal Reserve (the Fed) and the European Central Bank (ECB) in engaging in cheap credit. The Swiss did not need a super-loose monetary policy to fight the crisis: unemployment was low and the public debt was comfortably under control. Moreover, Swiss companies were in rather good shape. As a matter of fact, the SNB was trying to discourage investors from buying Swiss francs, so that the exchange rate would steer a middle course: drop against a strong dollar and rise against a weak euro. Although investors were happy with this choice, few observers underscored that to pursue exchange-rate stability, the SNB chose to abandon neutrality and de facto react to what the Fed and ECB were doing.

Once a central bank decides to use interest rates to pursue its policy goal, exchange rates end up being influenced by what politicians (including central bankers) say. This is exactly what has happened. When the president of the SNB let it be known that he would keep interest rates in negative territory, regardless of monetary policy in the dollar and euro areas, he not only announced a change of strategy, but he also confirmed that monetary policy was bound to remain a matter of discretion.

The EUR/CHF exchange rate over the past two years
The Swiss franc has weakened substantially against the euro in recent months, as the Swiss National Bank has taken on a more active monetary policy (source: macpixxel for GIS)

Pressure from manufacturers

Why would Switzerland need monetary activism? Its gross domestic product (GDP) growth is not much above zero. This may look bad to many EU politicians who need relatively fast growth to absorb unemployment and keep their debt-to-GDP ratios within tolerable limits. But low growth is hardly new for the authorities in Bern: the country has registered less than 1 percent average growth over the past 40 years. Moreover, Swiss exports are currently rising at a rate of 3.6 percent, imports are falling, investments are also doing well and GDP growth forecasts for 2017 and 2018 are being revised upwards. Public finances are under control (the debt-to-GDP ratio is below 33 percent) and Swiss companies do not seem to suffer from systematic difficulties.

By contrast, Swiss firms’ major problem seems to be the lack of workers (the unemployment rate is 3 percent). Last June, the SNB’s president justified his decision to pursue an ultra-generous monetary policy by mentioning the current rate of inflation, which is about 0.3 percent on an annual basis. Can one really claim that such a rate is too low for a country that traditionally aimed at price stability and in which inflation has been well below 2 percent for the past 20 years?

One is left wondering what is really driving the new Swiss policy-making vision and where Switzerland is heading. We put forward one hypothesis, from which two possible scenarios follow. The hypothesis is that Swiss manufacturers have captured monetary policy. They were taken by surprise in 2014 and January 2015, when the SNB refused to let the franc rise due to huge capital inflows, but later gave in and let the franc surge in a matter of hours.

To guess where the franc is going, one should listen to the CEOs of Switzerland’s export-oriented companies

Many companies were badly bruised and do not want to be surprised a second time. They have put pressure on the monetary authorities, and persuaded them to keep the franc relatively weak. If this is correct, speeches in favor of higher growth and scary stories about negative inflation are a smokescreen. To guess where the franc is going, one should listen to the CEOs of Switzerland’s export-oriented companies: they abhor abrupt swings in the exchange rate, and have become increasingly distrustful of policymakers.


Two scenarios could arise. If nothing dramatic happens globally, the Swiss monetary authorities could decide to play it safe and orient their exchange-rate strategy toward their largest trade partner – the European Union. In practice, this means neglecting the dollar and tracking the euro asymmetrically: let the euro rise (and the franc weaken) when the euro strengthens, and follow the euro when the euro depreciates. By doing so, they achieve several goals: They make sure that they improve Switzerland’s price competitiveness in its main export market; they neutralize (at least partially) the impact of future higher costs provoked by the shortages in the Swiss labor market; they gain breathing space for gradual CHF appreciation should Switzerland experience sudden inflows of foreign capital; and they remain almost immune to criticism from the international community. (How could one blame the Swiss if the euro appreciates?)

This is what has happened over the past several weeks. In public statements, ECB President Mario Draghi recently gave the impression that the bank is bound to allow interest rates on the euro to rise earlier than expected. This sparked an appreciation of the euro, and the franc adjusted, weakening against the euro and appreciating against the dollar. In this scenario, the future of the franc ultimately depends on what the financial markets believe the ECB will do.

So far, Swiss residents have refrained from using the additional liquidity to increase consumption

A second scenario could materialize if something unexpected happens domestically. So far, Swiss residents have refrained from using the additional liquidity created by the SNB to increase consumption. This explains the current low level of inflation. However, if the Swiss ramp up consumption and/or exports increase substantially, prices might suddenly surge. Will the SNB stay put and flaunt its ability to ignite inflation? Or will it react by increasing interest rates and avoiding capital inflows (and the appreciation of the franc) by introducing restrictions on capital movements?

In a world where all central banks are busy meddling with interest rates and act in accordance with the latest statistics, it is impossible to guess where exchange rates could be heading. Yet recent developments suggest that several key Swiss players are less than happy with the franc’s sudden appreciation, and that the alternative to higher interest rates in the euro area might be controls on capital movements in Switzerland.

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