Facing a surging Swiss Franc, the Swiss National Bank declared a new price ceiling for the Franc against the Euro. The SNB’s move can be interpreted as a peg between the Swiss currency and the currency of the European Union—the Euro.
Pegging a currency to another is nothing new. Currency pegs have existed in some form for centuries, and after World War II, every currency on earth was pegged to the dollar through the Bretton Woods agreement.
However, the Swiss National Bank’s decision is nothing like days gone by. The European Union faces a debt crisis fueled by growing public debts in Portugal, Italy, Greece, and Spain. Each nation, now grouped into the collective “PIGS,” faces the possibility of default. For the Swiss National Bank to enforce the new peg and price ceiling for the Swiss Franc, the Swiss will essentially underwrite the financing for the crisis in the rest of Europe.
Swiss Peg Unfavorable
In just one day—minutes, for those who are counting—traders quickly sold off the Swiss Franc as a safe haven currency. On September 6, 2011, the Swiss Franc plunged more than 9 percent against the US Dollar, and 8% against the Euro.
Previous to the new price ceiling on the EURCHF pair, investors used the Swiss currency as a safe store of wealth. Whereas the Euro was known to be in trouble, Swiss investments offered exposure to Europe, but also safety against the possibility of a European banking collapse.
One day after the decision to peg the Swiss currency to the Euro, the outlook has changed. The Swiss National Bank will have to buy an unlimited number of Euros with Swiss Francs, essentially agreeing to inflate the currency to whatever length necessary to keep its currency price relatively low against the Euro.
Cost to Peg Swiss Franc to Euro
Some estimates suggest the Swiss National Bank could expend up to $200 billion in capital to artificially lower the Franc’s value against the Euro. Bloomberg reports that just last year the Swiss central bank spent a whopping $15 billion in a failed attempt to stem the Franc’s rise.
Through the beginning of the year, the Franc gained more value than any other developed world currency, rising 4.6%. The US Dollar was world’s worst performer, losing just over 4% of its value to a global basket of 10 currencies.
The outlook for the Franc is negative, however traders seem happy keeping the Franc just above the 1.2 price ceiling enacted by the Swiss National Bank.
