Last week’s announcement that Switzerland decided it was no longer pegging its currency to the euro, could have been like a bolt from the blue. For many of us it even seemed like a bolt of very irrelevant news or may not even have been aware that the Swiss franc was pegged to the euro.
The immediate effect was quite clear to note, while possibly it was more confusing as to what it really implied. The immediate effect was a fall in the value of the euro, an increase in the value of the Swiss franc, and a drop of around 8 per cent in the index of the Zurich Stock Exchange.
What actually happened was that the Swiss central bank decided to remove the ceiling above which the Swiss franc was not allowed to go in relation to the euro. In recent weeks, as the value of the euro fell, the Swiss central bank had to intervene on a number of occasions to sustain the value of the euro, in order to protect the value of the franc. At a certain point, the Swiss central bank must have got to the conclusion that enough was enough and removed the ceiling on the exchange rate.
It would seem that because the decision was unexpected, and because the ECB has still started implementing quantitative easing, there is volatility in the financial markets
Why was there a ceiling in the first place? The pegging of the Swiss franc to the euro was in itself an indication of the level of economic integration between Switzerland and the eurozone. The pegging provided an element of protection against currency volatility.
So was the removal of the pegging mechanism (which, as I have mentioned, was in the form of a ceiling), a sign that it was costing the Swiss central bank too much money to support it? Was it a sign that the level of economic integration between the eurozone and Swiss franc got weaker? Or was it a sign that Switzerland is willing to look beyond the eurozone and start looking at the UK and the US?
I believe it was a bit of all three. Switzerland had introduced the pegging in 2011 as an extraordinary measure. However, with the weakening of the euro against the dollar, this also meant a weakening of the Swiss franc, which made the country lose an element of stability in its financial services sector.
Moreover, the outlook of monetary policy in Switzerland was becoming increasingly divergent from that of the eurozone. In order to mitigate the impact on competitiveness resulting from a revaluation of the Swiss franc, the Swiss central bank decreased its interest rate even further to -0.75 per cent.
There are many analysts who believe that this decision was taken in preparation of the implementation of the quantitative easing strategy expected to be taken on board by the European Central Bank. This strategy is likely to weaken the euro further and as such may be unsustainable for a currency such as the Swiss franc. After all, the Swiss currency was pegged to the euro as the latter acquired strength against the US dollar and the pound sterling.
However, in the short term, this decision could hurt the Swiss economy considerably. There is one estimate that Switzerland could experience a drop in its exports of goods and services of around five billion. Moreover the growth in the gross domestic product in 2015 could be as low as 0.7 per cent instead of the estimated 1.4 per cent.
The engineering sector exports around 80 per cent of what it produces to eurozone countries, mainly Germany. The revaluation of the Swiss franc could put into jeopardy a number of small- and medium-sized enterprises whose survival depends on such exports. The CEO of the watchmaker, Swatch, called this decision “a tsunami” for the Swiss economy.
The implications of this decision for the eurozone are as yet undetermined. In relative terms, the Swiss economy is a small one and as such the revaluation of its currency may not present many significant export opportunities for companies based in the eurozone. However, it would seem that because the decision was unexpected, and because the ECB has still started implementing quantitative easing, there is volatility in the financial markets. This volatility is bound to create uncertainty for the productive economy, which is never a good sign.