Swiss franc turmoil leaves exporters on the downhill slope

Ed Eger sleeps with his phone on. When you’re in the foreign exchange business, events around the globe can require a fast response.

At 4.40am Eger was jolted out of bed in Canada by a call from a colleague. Four thousand miles away in Bern, Switzerland, policymakers had announced a decision that would give traders one of their roughest days since the financial crisis.

The Swiss National Bank (SNB) had decided to tear away the ceiling it had held on the Swiss franc’s value, which it had put in place during the heights of eurozone panic, in 2011. The central bank had put massive pressure on the currency, holding it down against the euro by printing enough francs to keep it cheap.

The franc had been held down by the SNB like the cork in a well shaken bottle champagne bottle. On January 15, the central bank’s controls were removed, and the currency shot up. At the time Eger got the call that woke him, the franc was 20pc higher against the euro. It peaked at around 30pc, as he was scrabbling for something to wear.

As Eger arrived at Oanda, the Toronto-based foreign exchange firm of which he is CEO, it was clear that the industry as a whole was in trouble. “I was at Citigroup during the financial crisis, so this was not my first rodeo,” said Eger.

“We are well capitalised, and a strong player in the industry, which is why we feel comfortable coming out of this,” he added. Compared with some of its peers, Oanda emerged relatively unscathed. West Ham’s then shirt sponsor Alpari, a London-based foreign exchange trader, collapsed into administration on the back of the beating it endured.

The decision had come as a complete shock to the markets. Earlier that month Thomas Jordan, the SNB’s chairman, had described the cap as “absolutely central”. It had seemed to become a permanent feature of the Swiss landscape.

While the immediate moves in the franc were extreme, the repercussions have been relatively tame compared with what comes next for the Swiss economy. Just one in five Swiss companies had prepared themselves for such a move with the use of hedging products, according to a survey by Credit Suisse and Swiss trade association Procure.ch.

Faced with a tidal wave of liquidity in the form of a European Central Bank (ECB) quantitative easing package, the SNB had to resort to creating vast amounts of money in order to keep the franc weak against the tumbling euro.

Its own balance sheet could have reached a “gargantuan size” once QE arrived in full, said Paul Mortimer-Lee, of BNP Paribas. This put the SNB “in an increasingly risky position”, forcing it to quit before the situation was entirely out of hand.

A week later, the European Central Bank would deploy tremendous monetary firepower – a €1.1 trillion (£830bn) quantitative easing package – aimed at reviving a weak eurozone economy.

It was this that the SNB had wanted to shield itself from. Jordan defended his shock strategy as the central bank’s only option. “If you decide to exit such a policy, you have to take the markets by surprise,” he said. Yet it seems unlikely that the SNB was fully prepared for the extent of the turbulence that would follow. And in doing so, Jordan may have condemned his own country to permanently lower growth.

A once respected central bank took the blow to its credibility just days before the great and the good met to assemble in Davos for the World Economic Forum annual meeting. At an event in which monetary policy’s power was a hot topic of debate, the SNB’s capitulation – it had been intervening heavily to weaken the franc – made it appear weak.

Lars Christensen, an analyst at Danske Bank, described the move as a “terrible decision”. Instead of replacing its rule with something better, the SNB “seems simply to have given up having any monetary policy rule at all”, he said.

The SNB’s perceived weakness in defending its own de facto peg has caused investors to look around for others who might follow. Denmark’s central bank has been forced to cut its own interest rates four times in just three weeks in order to defend its own peg.

The SNB had already allowed Switzerland to flirt with slight deflation. Lower oil prices alone had been responsible for a recent acceleration. In the year to December, prices fell by 0.3pc, their steepest decline since October 2013.

A lack of inflation had not been particularly troublesome, as it had been accompanied by solid growth, despite many of Switzerland’s European trading partners being mired in economic stagnation. In fact, it had acted as a kind of good deflation, providing a boon to savers.

The primary risk of deflation – that the burden of government debts become harder to pay – did not apply in the Swiss case. The government has managed to post budget surpluses, rather than deficits.

But good deflation can turn to bad. Standard and Poor’s, a ratings agency, said that “a stronger Swiss franc is likely to weaken economic growth and deepen deflationary pressures”. The Credit Suisse and Procure.ch report showed the sharpest decline in the Swiss economic outlook in January since the midst of the financial crash, in November 2008.

Its purchasing managers’ index (PMI) shed 5.3 points in January, falling to 48.2. Falling below the 50 level, the index implied that the Swiss private sector has begun contracting. A sub-component of the survey – the purchase prices index – fell by an alarming 26.7 points to an all-time low of 21.2.

Michael Saunders, of Citi, said that the readings “highlight the severe deflationary shock to the Swiss economy”. Along with the slump in oil, “the Swiss economy is set for marked economic weakness and a sizeable drop in inflation this year”, he added.

Forecasters have even suggested that an economy seen as solid and reliable could now shrink, as deflation becomes entrenched. The KOF Swiss Economic Institute anticipates a recession over the summer, and that GDP will fall by 0.5pc across the whole of 2015.

Most vulnerable to the franc’s swift appreciation have been Switzerland’s exporters, responsible for more than 70pc of GDP. Nick Hayek, CEO of watch maker Swatch, immediately condemned the move as a “tsunami for the export industry and tourism, and finally for the entire country”.

Their exposure to the franc will lead to a sustained drop in growth. Veronica Weisser, of UBS Wealth Management, said that some companies will have to close their doors.

Exporters will go through “a very tough period”, she said, and depending on their savings may not be able to survive a difficult two to three years. Since the move, 14pc of Swiss corporates have begun considering relocating abroad or have frozen investment and recruitment.

Even the country’s ski resorts are under threat. With a franc now 12pc more expensive than a month ago, European holidaymakers may be looking towards Austria as an alternative. Swiss skiers may be considering the same options, as their francs go further in euros.

What has happened in Switzerland might be a sideshow compared with larger global players, but is illustrative of a world in which central banks are increasingly looked to for answers. Limp growth since the crash has put greater burdens on their shoulders. When their calls go wrong, the tremors that result can be significant.

While the SNB’s balance stood at just 85pc of GDP before the cap was pulled, it could have quickly grown to 200pc to 300pc of GDP within a year or two. “With that type of even larger balance sheet, if you ever wanted to get out, the economy would suffer even more,” Weisser said.

Faced with a choice between a hit to its economy now or the possibility of a large one later, the SNB chose to swallow pain now. “In a way they were brave,” Weisser said, although it will be “impossible to judge” whether its choice averted a greater crisis.