By Gillian Tett
Another week, another bout of eurozone jitters. No wonder that Jean-Claude Trichet, and George Papandreou – not to mention Angela Merkel – look badly in need of a summer holiday.
But as the eurozone writhes in pain, it is worth sparing a thought for a separate, but symbiotic, dilemma that is gripping Switzerland’s central bank.
To be sure, Zurich does not appear to have that much to panic about. Switzerland’s growth rate has recently been the second highest in Europe (beaten only by Slovakia). Last year – quite remarkably – the country even managed to cut its debt.
But in today’s topsy-turvy world, this commendable “success” is what is giving the Swiss National Bank a headache. Most notably, as global investors increasingly try to diversify away from the troubled eurozone, many are turning to Switzerland. Although Swiss denominated assets are limited in volume and by and large do not produce high returns, they do generally offer the promise of capital preservation. Nowadays that makes them akin to gold.
So, as money floods into Switzerland, this is creating huge pressure for Swiss franc appreciation against the euro, particularly since the only way that many investors can actually express their enthusiasm for Switzerland, given the limited range of assets, is by playing the forward currency market.
During most of the last year, those gnomes at the SNB managed to keep a lid on these pressures by unleashing a massive unsterilised intervention. Between April and May, for example, the SNB’s currency reserves leapt more than 50 per cent from $145.6bn to $261.9bn, an expansion so remarkable in scale that (as my colleague Peter Garnham recently observed) it has only been topped by China twice before.
Last month, however, the SNB appeared to row back from this stance. The Swiss franc has since appreciated by some 7 per cent on a trade-weighted basis, as investors frantically try to work out what the once-dull SNB will do next.
It is not easy to tell. Unsurprisingly, the rise in the franc has prompted horror from Swiss exporters, particularly since this could soon accelerate. Eurozone banks with big exposures to countries such as Hungary are worried, since a high proportion of Hungarian mortgages are Swiss-denominated.
The SNB claims that it is reluctant to keep intervening. Ostensibly this is because it is looking for an exit strategy from the unorthodox monetary policy measures. But there is also a political tale at work. Most notably, one unintended consequence of the intervention is that the SNB’s holdings of eurozone assets have risen dramatically in recent months. The SNB has tried to handle that risk by diversifying into currencies such as sterling or Canadian dollars and by only buying the “safest” eurozone bonds (i.e. nothing Greek or Spanish).
That, however, has not protected it from pain. Thus next month the SNB is likely to reveal that it has suffered paper losses worth a couple of billion Swiss francs because of eurozone woes. From a macro-economic perspective that should not really matter; those paper losses may be reversed in the future and in any case could easily be absorbed by the SFr17bn of reserves the SNB has amassed in recent years.
But Switzerland is a conservative place and Philipp Hildebrand, SNB governor, is under fire from the Swiss banking community because of his tough stance on regulatory reform. Thus, news of those losses could easily spark a bigger political row; indeed, it is creating behind-the-scenes controversy about the whole intervention policy.
This obviously matters greatly to Swiss exporters (or Hungarian homeowners), though it might have wider implications, too. After all, the SNB is not the only central bank that has engaged in bold policy measures recently: the Bank of England has been gobbling up gilts, the Fed has acquired mortgage bonds and the European Central Bank is buying eurozone bonds.
Thus far, there has been little public debate about who will bear losses from this, if they arise. And the Bank of England thinks (or hopes) this will never be a problem in countries such as the UK, since the British central bank is clearly indemnified by the government (meaning that the UK government pays).
But in other countries, the legal pattern is less clear (and the ECB is not actually indeminified by a government at all). Moreover, it remains an open question how the markets – or voters – might really react to losses if these arise.
Investors around the world would be wise to keep watching closely what does, or does not, happen next in Zurich. Barring a miracle – i.e. eurozone stabilisation – the SNB faces a tough task. I, for one, do not expect to see that miracle anytime soon.
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