In Europe, Switzerland is an Island
Switzerland’s central bank surprised the global markets on January 15, when it abandoned the cap on its currency’s value against the euro. Back in 2011, the Swiss central bank pegged its currency at 1.20 Swiss francs per euro.
Why? Because Switzerland has long been considered an economic safe haven, with investors wanting to hold the currency as a hedge against economic uncertainty. Before the cap was put in place, the strong Swiss franc and weakening sales to the economically ravaged eurozone (and U.S.) put a strain on Switzerland’s economic growth.
The Swiss central bank saw a strong currency as a threat to the nation’s economy, especially in light of the eurozone, which is straddled with debt and teetering on recession.
Enter the currency cap.
In 2011, the year the cap was introduced, Swiss companies had to cut prices by more than five percent just to keep exports alive. This isn’t a total surprise when you consider that Germany, the biggest economy in the eurozone, is Switzerland’s largest national trading partner; the U.S. comes in a close second.
But the tides have changed since 2011. The eurozone is still an economic mess, but the U.S. has experienced an economic renaissance, with a Swiss franc pegged with the euro now weakened significantly against the U.S. dollar.
Switzerland Lets Currency Run
To help shore up its currency, the Swiss central bank made the sudden move to unhinge its currency from the euro and let it run free. After the unexpected announcement, the Swiss franc soared 30% against the euro, while the Swiss stock market fell 10%.
The market fell because a strong Swiss franc means it will be more expensive to purchase products made in Switzerland. This could negatively impact exports, as the European Union accounts for the majority of the country’s exports. A higher Swiss franc could also hurt tourism.
While many question the Swiss national bank’s move, the fact is that it might have been a shrewd move. It has long been expected that the European Central Bank will formally announce it is adopting a generous bond-buying program, known as quantitative easing (QE), at its next meeting or subsequent meeting in March.
In light of any QE measures, a strong economy like Switzerland, pegged to a fragile currency like the euro, would face further pressure.
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Allen, M., “Exporters pick path through economic minefield,” SwissInfo.ch, February 13, 2012; www.swissinfo.ch/eng/specials/swiss_franc/Exporters_pick_path_through_economic_minefield.html?cid=32112416.