SNB faces battle to maintain franc currency floor

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The Swiss National Bank (SNB) may struggle to maintain a minimum exchange rate of Sfr1.20 against the euro, despite pledging to purchase "unlimited" quantities of foreign currency to reinforce the Swiss franc floor, analysts have said.

On Tuesday, the SNB took the unprecedented step of announcing a minimum exchange rate for the Swiss franc, saying it would "no longer tolerate a euro/Swiss franc exchange rate below the minimum rate of Sfr1.20".

Shortly after the SNB's announcement, Philipp Hildebrand, chairman of the SNB's governing board, said the central bank was prepared to buy foreign currency in "unlimited quantities". He added that even though a rate of Sfr1.20 per euro was still at a "high level", it would enforce the minimum rate with the "utmost determination".

The Swiss franc immediately lost 8.41% of its value against the euro following the announcement, and traded at Sfr1.2025 at 2:30pm London time.

Nick Stamenkovic, an economist at RIA Capital Markets, a brokerage based in Edinburgh, said previous experience suggested exchange rate targets will prove a serious challenge for the Swiss central bank. "The market is going to test the SNB's mettle and its commitment to the exchange rate target. While it has unlimited intervention capacity, markets are very powerful agents, and it's not clear this policy will be successful," Stamenkovic told Risk.net's sister publication, CentralBanking.com.

Jennifer McKeown, a senior European economist at Capital Economics, a consultancy based in London, agreed. She said that while the SNB's limit of Sfr1.20 per euro was a "bold move", there may be limits to how many francs the bank is prepared to print. "I think [the SNB] would struggle to maintain the new lower value for the franc for long. Capital controls can't really be applied in Switzerland as they have been in China, because that would jeopardise Switzerland's position as a global financial centre," she said.

However, Marc Ostwald, a strategist at Monument Securities, said he expected the SNB to be "good to its word", adding that he expected "any movements to pressurise [the Swiss franc] back down through Sfr1.20 to be met with a hefty amount of selling". Ostwald said the move brings the Swiss franc to a "vaguely manageable" level rather than the over-valued level relative to the euro.

The timing of the move came as a surprise to markets, according to Stamenkovic. "I don't think anyone expected such drastic action from the SNB. There have been discussions of something more radical, but central banks tend to wait a little longer before they implement something as aggressive as this," he said.

The franc has surged by nearly a third against the euro since the collapse of Lehman Brothers in September 2008, as investors sought safety in the Swiss currency. This prompted the SNB to launch a series of interventions during 2010 in a bid to contain the franc's appreciation.

In June last year, the central bank halted the interventions, saying in its monetary policy statement that the deflationary risk posed by excessive franc appreciation had "largely disappeared". However, the Swiss franc has since gained 19.5% against the euro as the eurozone debt crisis forced investors to once again flock to the safety of the franc.

The strength of the Swiss franc poses a serious threat to Switzerland's export market, which shrank by 1.3% in the second quarter. With GDP of 0.4% in the second quarter of 2011, down from 0.6% in the first quarter, there are growing concerns the Swiss economy may be falling into recession.

In an attempt to curb a further strengthening in the Swiss franc, the SNB injected Sfr170 billion of liquidity into money markets in the space of two weeks during August. The SNB had vowed to take further measures against the "overvalued" Swiss franc, with Thomas Jordan, the vice-chairman of the SNB, unwilling to rule out the possibility of a pegging the franc to the euro, in an interview with TagesAnzeiger, a Swiss newspaper.

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