SNB bond-buying ‘exacerbating’ euro fragmentation – S&P

Purchases of ‘core' eurozone bonds by the Swiss National Bank (SNB), estimated at €80 billion ($103.7 billion) in the first seven months of this year, have "significantly contributed to the declining yields on bonds issued by the core sovereigns during 2012", according to a report issued today by rating agency Standard & Poor's (S&P). S&P said the ‘blended average' 10-year yield of core sovereigns stands at 2.15% year-to-date, versus 3.04% in 2011.

"Largely unnoticed, Switzerland's decision to stem the appreciation of the Swiss franc has led to a de facto recycling of funds from the eurozone periphery to its core, via the SNB," said Frank Gill, report author and credit analyst at S&P. "We think this 'euro-recycling' is exacerbating the trend of diverging market conditions for sovereign bonds in the eurozone," said Gill.

European policy-makers and central bank officials are scrambling to send out a message that all the countries currently in the euro area will remain in the zone. However, large discrepancies between sovereign bond spreads reflect a market view that there is a risk of a break-up, something S&P believes the SNB's actions are reinforcing.

The development has arisen following the introduction by the SNB of a minimum exchange rate of Sfr1.20 to one euro in early September last year in a bid to counter a rapid appreciation of the Swiss franc. The SNB said on March 15 that it would continue to enforce the minimum exchange rate "with utmost determination", adding it was "prepared to buy foreign currency in unlimited quantities for this purpose".

The SNB said in a statement that the S&P report "contains a fundamental error". "It ignores the sizable increase of SNB deposits with other central banks and international institutions which are published monthly by the SNB," the SNB said. "The conclusion by S&P that the Swiss National Bank has bought about €80 billion of government bonds of core eurozone countries is unfounded."

"Largely unnoticed, Switzerland's decision to stem the appreciation of the Swiss franc has led to a de facto recycling of funds from the Eurozone periphery to its core, via the SNB

S&P said the €80 billion figure was an "estimate" as the SNB does not detail its foreign exchange holdings. Gill said while the estimates are "subject to some uncertainty" the "scale of the buying is without question".

S&P said core euro bonds include those issued by Germany, France, the Netherlands, Finland and Austria.

In its accountability report for 2011, the SNB revealed that last year it purchased foreign currency to a value of about Sfr17.8 billion ($19.6 billion) to maintain the minimum exchange rate against the euro and "combat the massive overvaluation of the Swiss franc".

"The SNB's eurozone bond-buying during the seven months of 2012 is equivalent to about 48% of the combined full-year deficits we estimate for the eurozone core for the whole of 2012, up from 9% in 2011," S&P said in the report. "In our view, this has significantly contributed to the declining yields on bonds issued by the core sovereigns during 2012."

Switzerland's balance of payments has changed significantly since the start of the global financial crisis, with the Swiss private sector hoarding cash at home. Meanwhile, Swiss banks have cut their claims on the eurozone periphery and experienced large inflows of deposits from investors seeking a ‘safe haven' for their money.

The result is that current and financial account surpluses have driven "an unprecedented surge in the foreign exchange reserves held at the Swiss National Bank to 79% of GDP in mid-2012 from 15% of Swiss GDP in mid-2008", according to S&P.