Switzerland had no choice but to withdraw its commitment to maintain a floor of 1.2 Swiss francs to the euro in January 2015 or it would have faced an “enormous speculative attack”, according to Thomas Jordan, chairman of the Swiss National Bank (SNB).
Failure to have shifted policy from the floor would have resulted in a ballooning of the SNB’s balance sheet – already swollen to around $750 billion – with no upside benefit, Jordan tells Central Banking journal in an in-depth interview published on July 31.
Jordan explains that the problems emerged after the euro started to decline against a basket of the world’s reserve currencies in late 2014. Following this, the Swiss franc, too, started to weaken against those currencies with the SNB predicting further euro weakness in 2015. This meant preserving the three-year-old currency barrier became unsustainable.
“Maintaining the minimum exchange rate toward the euro would have created completely distorted exchange rates for the Swiss franc with regard to the US dollar, sterling and other currencies,” says Jordan. “Soon, every market participant would have realised that this policy was no longer sustainable. We would have been faced with enormous capital inflows and a self-reinforcing speculative attack.”
He also defended the central bank’s decision not to forewarn market participants, despite making previous assurances the SNB would defend the euro floor with the “utmost determination”.
No signal benefit
The Zurich-based Swiss central bank chief says there was no desire to shock the market but the circumstances were such that there was no other option.
“Signalling the exit from this policy in advance would have generated an enormous speculative attack on the franc,” says Jordan. “This would have led to an explosion of our balance sheet without any benefit. In addition, it would have weakened our ability to conduct an effective monetary policy going forward.”
The SNB abandoned the euro currency floor in favour of negative interest rates and a declared willingness to intervene in the foreign exchange market “if necessary”, a policy it maintains today.
The SNB’s actions were criticised by many market participants at the time. Dealers said options portfolios were almost impossible to delta hedge while retail brokers attempted to reprice trades.
Their move also had an impact on other central banks.
“I don’t think anybody would like us to surprise the market by dramatically changing our policy like the Swiss did,” Miroslav Singer, the former governor of the Czech National Bank – which had a floor of 27 koruna to the euro until last year – told Central Banking in an interview in 2015.
“The Swiss were obviously over-anxious not to create any suspicion that anyone had advance knowledge of the move, which is understandable given the problems experienced by the previous governor when they introduced the floor,” he added.
But Jordan said it was unfair to contrast the two episodes.
“You cannot compare the Swiss situation with the Czech case because the Swiss franc is an international reserve currency and serves as a safe haven,” says Jordan. “We had to exit in a situation where the euro had weakened substantially against the major currencies.”
He adds: “Signalling the exit from this policy in advance would have generated an enormous speculative attack on the franc. This would have led to an explosion of our balance sheet without any benefit. In addition, it would have weakened our ability to conduct an effective monetary policy going forward.”
Jordan says “many citizens, market participants and business leaders” had “respected” the SNB’s decision to act “without giving anyone privileged information”.
“Ultimately, everybody was affected in the same way,” he adds.
Limited damage to reputation
Jordan dismisses suggestions the sudden withdrawal of the floor damaged the central bank’s reputation.
“Given the unsustainable nature of the situation, waiting and postponing the decision would have been the worst option,” says Jordan. “By deciding quickly to discontinue the minimum exchange rate, we chose the option that was best for the country and that also enabled us to keep up an effective monetary policy in the future to fulfil our mandate.”
Jordan says postponing a decision viewed as “absolutely necessary” would have “truly damaged the reputation of the SNB”. “We maintained our credibility by taking the decision to discontinue the minimum exchange rate at the right time; our credibility would have been eroded if we had shied away from this decision,” he says.
Combating Swiss franc strength
The SNB introduced a floor for the Swiss currency against the euro in 2011 after the Swiss franc became “massively overvalued” in the northern hemisphere’s summer of 2011, according to Jordan.
“The minimum exchange rate was an effective instrument to fight this isolated Swiss franc strength,” says Jordan, adding: “If the SNB had not acted in autumn 2011, the economy would have fallen into a depression.”
Jordan says that the minimum exchange rate stabilised the Swiss franc at a level that “was bearable for the economy” and avoided “deflationary spiral”.
“It was a very effective tool both to stabilise the economy and ensure price stability.”
But the policy came with an immediate cost after it emerged that the wife of then SNB chairman Philipp Hildebrand had made large forex trades at the time of the introduction of the peg.
The debacle forced Hildebrand to resign and resulted in a hiatus at the SNB, as a forensic investigation by the government delayed the formal appointment of Jordan as the SNB’s new chairman by several months.
Jordan says these were difficult times.
“The first task for my board colleagues and me was to ensure the stability of the bank,” Jordan says. “We faced quite a long period of institutional uncertainty. At the same time, there were huge challenges for our monetary policy as the European sovereign debt crisis reached a peak in 2012.”