In monetary policy terms at least, the summer of 2011 was a hot one in Switzerland as the European debt crisis deepened. The euro depreciated substantially. Many investors were therefore keen to park their money in safe Swiss francs. This surge in demand caused the Swiss franc to appreciate rapidly against other major currencies. At times, one euro cost almost as little as one franc; two years previously, one euro had cost around CHF 1.50. Crisis meetings came thick and fast at the SNB. The economy, which had only just got back on its feet after the financial crisis, now had to grapple with huge appreciation. The exceptionally strong Swiss franc presented a major challenge for companies exposed to global competition, and Switzerland’s economy faced an acute risk. As the risk of deflation grew, so too did the threats to price stability.
The SNB had to act in order to fulfil its mandate. It therefore cut interest rates further and massively increased the monetary base. These measures had some effect, but the upward pressure on the Swiss franc persisted and intensified again at the beginning of September 2011. The SNB thus went one step further, setting a minimum exchange rate of CHF 1.20 per euro on 6 September 2011 and underscoring its willingness to enforce the policy with the utmost determination. This measure capped the substantial appreciation of the Swiss franc.
As the exchange rate plays an important role in price developments and the business cycle, the SNB has always kept a very close eye on the Swiss franc’s performance against other currencies. The introduction of the minimum exchange rate in September 2011 was actually not a first for Switzerland: in September 1978, the SNB had set a minimum exchange rate for the German mark against the Swiss franc. It declared that the franc had to trade at well above 80 francs for 100 German marks. This minimum exchange rate, too, was enforced via foreign exchange market interventions, as and when these proved necessary.
For almost three-and-a-half years, the minimum exchange rate was the right monetary policy tool to ensure price stability in Switzerland and avoid a recession.
An exchange rate is nothing more than the price of a currency expressed in another currency. At a euro/Swiss franc exchange rate of 1.20, one euro costs CHF 1.20. If the exchange rate is 1.10, a euro only costs CHF 1.10, i.e. the euro has become cheaper and the Swiss franc more valuable. In other words, if the euro/Swiss franc rate exchange rate falls, the Swiss franc appreciates. As in the goods market, the price of a currency rises when demand (in this case for Swiss francs) increases.
This was precisely the approach the SNB adopted: whenever the minimum exchange rate came under pressure, it purchased euros – occasionally in very large quantities – and paid for them with newly created Swiss francs. This policy increased the supply of Swiss francs and the demand for euros, allowing the SNB to keep the value of the franc stable and influence the exchange rate in a targeted way.
The key here is that, because the SNB has a monopoly on banknote issuance, it can create unlimited quantities of Swiss francs. The SNB was thus not only willing, but able, to enforce the minimum exchange rate, and this gave it the required credibility. The market knew that the SNB was in a position to pay CHF 1.20 for one euro at all times as long as it was prepared to uphold the minimum exchange rate regime.
The SNB consistently emphasised that it would enforce this minimum rate ‘with the utmost determination’ and that it was prepared to buy foreign currency in unlimited quantities. This determination was put to the test in the summer of 2012 when the SNB was obliged to buy enormous quantities of euros. From autumn 2012, the situation calmed down, and the SNB did not have to defend the minimum exchange rate through foreign currency purchases in 2013. However, towards the end of 2014 the euro weakened against all currencies. The euro/Swiss franc exchange rate again edged closer to the minimum exchange rate and the SNB had to intervene in the foreign exchange market once more. In an effort to make Swiss franc investments less attractive and thus support the minimum exchange rate, the SNB announced the introduction of negative interest rates on 18 December 2014.
Thanks to round-the-clock monitoring of the foreign exchange market, the SNB was able to ensure that the minimum exchange rate of CHF 1.20 per euro was not breached.
The minimum exchange rate was only ever intended to be an exceptional, temporary measure. In the period during which it was in place, the environment changed significantly. In contrast to 2011, the environment at the beginning of 2015 was no longer characterised by Swiss franc strength, but by euro weakness. The European Central Bank (ECB) had once again begun to loosen its monetary policy. It thus became clear that the minimum exchange rate could only be upheld through increasingly large foreign exchange market interventions – with no prospect of a long-term stabilisation on the exchange rate front.
Maintaining the minimum exchange rate under such circumstances would have led to an uncontrollable expansion of the SNB’s balance sheet, which, in turn, could one day have resulted in the SNB losing control of its monetary policy. The instrument was thus no longer sustainable. Turning a blind eye to this fact would, in the long term, have undermined the SNB’s ability to conduct independent monetary policy in Switzerland. The risks of continuing to adhere to the minimum exchange rate would have been out of all proportion to the benefits, particularly as the global economy – and Switzerland’s economy – were more robust by early 2015 than they had been in 2011.
At 10.30 precisely on 15 January 2015, the SNB discontinued the minimum exchange rate. The announcement took everyone – the markets, the media, politicians, international players and the Swiss public – by surprise. Foreign exchange markets were rocked in the wake of the move, with the EUR/CHF exchange rate falling to CHF 0.85 per euro in the immediate aftermath. But the situation soon calmed, order was restored and exchange-rate volatility subsided.
Why didn’t the SNB adopt a more gradual approach and discontinue the minimum exchange rate in stages, or announce its intentions long in advance? In fact, the SNB had no choice but to act in the way it did. Any hint that the SNB was no longer fully committed to the minimum exchange rate would have generated huge pressure on the foreign exchange market and would have forced it to intervene on an even larger scale to defend the minimum exchange rate.
As soon as it became clear that a discontinuation was unavoidable, the SNB acted swiftly. Had it delayed the decision to discontinue the minimum exchange rate, the turmoil on the financial markets and the effects on the economy would have been no less severe – and the SNB’s losses would have been substantially larger.