Category — Currencies

On today’s European Chat traders were asking me why the Swiss Franc took such a precipitous drop. Here’s the answer:

Right now, the Swiss are desperate to push their currency lower – especially versus the euro.

Swiss exporters are getting clobbered by the strong franc this year. A ton of Switzerland’s exports are shipped throughout Europe, so the Swiss have to worry about the EUR/CHF exchange rate, even more so than the USD/CHF exchange rate.

Swiss exports have fallen 17% in the past year. Ouch!

The only thing the Swiss can do to stop it is sell francs like crazy and keep their interest rates exceptionally low. They have to push interest rates lower enough so investors have no desire to buy francs vs. other currencies, particularly the euro.

When the exchange rate with the euro dropped below 1.45, the Swiss National Bank cried “uncle.” They simply couldn’t afford to let their exporters suffer anymore. If that trend continued it could put many of the exporters out of business and skyrocket the nation’s unemployment.

The Swiss National Bank has said before that they draw the line when the EUR/CHF exchange rate reaches the 1.50 level. They want the exchange rate to stay at that level or they’ll intervene in the market.

The Swiss National Bank has already done that several times over the past couple of months. That’s what stopped the exchange rate from falling notably below 1.50.

Can it drop below that? Sure! However, if it does, you can bet the Swiss central bank will sell an unlimited amount of francs to get the desired result over time. In fact, Chairman Roth explicitly said that, “keeping a lid on the franc is a key element of policy.”

This means the Swiss National Bank will keep rates near zero percent (0.25%). They will also be very quick to pump large amounts of francs into the market and water down the franc. They can sell francs and buy euros all day long if they need to.

At this point, they don’t have to worry much about inflationary effects as they do deflationary effects. Yes, the central bank is saying that their inflation rate may be near zero on into 2011.

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