Switzerland opened a new round in a global currency war as fading economic growth forces policy makers to step up efforts to spur expansion.
The Swiss National Bank’s decision yesterday to cap the franc’s rate for the first time since 1978 marked a bid to protect trade hurt by the currency that last month strengthened to records against the euro and the dollar. The franc plunged 8.1 percent yesterday against the euro, the most since the creation of Europe’s single currency. It was little changed at 1.2058 per euro at 10:53 a.m. in London.
The initiative may leave Norway and Sweden vulnerable to unwanted gains in their currencies as countries such as Brazil and Japan fight to limit appreciation amid a flight from the euro debt crisis and near-zero U.S. interest rates. With Group of Seven finance chiefs set to hold talks this week, it also exposes the clash among policy makers counting on exports to offset slumping demand at home.
“We will see a lot more intervention now, we will see manipulation on a grand scale,” said Stuart Thomson, who helps oversee about $120 billion as a portfolio manager at Ignis Asset Management in Glasgow. “Traditional safe havens are trying to undermine the value of their currencies.”
Line in Sand
The Swiss central bank said yesterday it is “prepared to buy foreign currency in unlimited quantities” to keep the euro above 1.20 francs after previous sales, injections of liquidity into the money market and zero borrowing costs failed to repel investors seeking bigger or safer returns than those offered by the U.S. or euro area. Swiss companies including watchmaker Swatch Group AG say the franc’s strength is weighing on earnings and a slump in exports was among the reasons why the economy slowed in the second quarter.
The SNB’s unilateral move puts it head-to-head with a $4 trillion-a-day currency market that drove the franc up more than 16 percent against a basket of nine major peers in the year through Sept. 2, according to Bloomberg Correlation-Weighted Currency Indexes. The euro fell 1.3 percent over the same period, while the dollar declined 12 percent, the indexes show.
The strategy shift is a sign other central banks may seek to weaken exchange rates in what Brazilian Finance Minister Guido Mantega last year labeled a “currency war,” said David Bloom, global head of foreign-exchange strategy at HSBC Holdings Plc. London-based HSBC yesterday cut its forecast for global economic growth this year to 2.6 percent from 3 percent and called a healthy recovery a “distant dream.”
Trying to Win
“As we hit the zero bound in interest rates, central banks have shifted to exchange-rate policy, aiming to have the weakest currency in town,” Bloom said. “This is a game that everyone can’t win, but that doesn’t mean they won’t keep trying.”
Japan last month spent 4.51 trillion yen ($58 billion) on yen sales, the biggest intervention for any month since 2004, and Finance Minister Jun Azumi said yesterday he will highlight the dangers of the yen’s gains at a G-7 meeting in Marseille, France, on Sept. 9-10.
Brazil’s Mantega last week said he hoped a reduction in his country’s benchmark interest rate would help limit an appreciation in the real that he has sought to fight through tax policy and trade barriers.
Led by China, all of Asia’s 10 biggest economies last year sought to influence their own exchange rates to aid exporters as the dollar fell. The Dollar Index, which tracks the greenback against the currencies of six U.S. trading partners, has fallen about 9 percent in the past year, as the U.S. Federal Reserve kept its key rate near zero and bought $600 billion of bonds between November and June.
Other economies also may be forced to join the fight, said Geoffrey Yu, a foreign-exchange strategist at UBS AG in London. “If people leave the franc and the yen and get crowded into the likes of Sweden and Norway, how far are the local economies going to tolerate their currencies strengthening before they do something as well,” he said.
HSBC yesterday recommended Norway’s currency as an alternative after the SNB’s action. The krone has strengthened 4.5 percent against its nine major peers over the past year, Bloomberg’s correlation-weighted indexes show, prompting Finance Minister Sigbjoern Johnsen and central bank Governor Oeystein Olsen to signal they’ll act to stem currency gains that hurt exports.
Japanese policy makers are “unlikely” to follow Switzerland’s move to set a franc ceiling because their economy is so much bigger, said Masaaki Kanno, the Bank of Japan’s former chief foreign-exchange dealer and now chief Japan economist at JPMorgan Chase & Co. Japan’s gross domestic product is the world’s third largest.
“The big difference between Switzerland and Japan is size of economy,” he said. If Japan set an upper limit for the yen at 75 or 70 per dollar, it would need to purchase a potentially “infinite” amount of dollars, something that would upset the U.S., he said.
Thanos Papasavvas, head of currency management at Investec Asset Management Ltd., which oversees about $95 billion in London, said he thinks the Swiss intervention will work because the franc was “extremely expensive” while other nations with less excessive valuations may struggle to influence their currencies.
“Simply intervening in the franc won’t solve all the world’s problems, but it might help markets be more balanced in their herd-like panic,” said O’Neill.
Switzerland’s move also demonstrates how three years since the collapse of Lehman Brothers Holdings Inc., central banks are having to adopt new tools to boost growth after cutting interest rates at or near record lows, buying bonds and injecting billions in their financial systems, said Neil MacKinnon, global macro strategist at VTB Capital in London.
With its second round of bond buying failing to spur growth or hiring, the Fed may decide at its Sept. 20-21 meeting to replace short-maturity Treasuries in its $1.65 trillion portfolio with long-term bonds to lower rates on everything from mortgages to car loans, say economists at Barclays Capital and Wells Fargo & Co. Citigroup Inc. and Goldman Sachs Group Inc. see the Bank of England resuming bond purchases as early as this week.
“The financial and economic crisis has tested the innovative powers of central banks,” said MacKinnon, a former U.K. Treasury official. “Conventional tools such as rate reductions and currency intervention have failed to work and that reflects the extraordinary times in which we live.”