Switzerland ditches currency peg, gets much more expensive

Though the timing of the Swiss decision proved a surprise, most foreign exchange experts thought the peg would have to be abandoned, just as previous such efforts had.

Bowing to the inevitable, Switzerland has ditched an increasingly expensive policy to limit the export-sapping rise of the Swiss franc — a decision that propelled the currency a whopping 30 percent higher against the euro within minutes.

Thursday's decision by the Swiss National Bank, or SNB, to end its efforts to keep the euro from trading below 1.20 francs came amid mounting speculation that the European Central Bank will next week back a big stimulus program that will put more euros in circulation, which would further dilute their value.

That expectation has seen the euro face intense selling pressure in currency markets, particularly against the dollar. The euro has fallen to nine-year lows against the dollar and below its launch rate in 1999.

As the outlook for the euro has darkened, the cost for the Swiss central bank of defending the peg by buying euros or sellingfrancs has risen. Though the timing of the Swiss decision proved a surprise, most foreign exchange experts thought the peg would have to be abandoned, just as previous such efforts had.

The scale of the Swiss central bank's task was evident in the franc's movements in the markets after it abandoned the peg. In some of the most dramatic moves seen in currency markets for decades, the euro plunged a stunning 30 percent against thefranc in the minutes after the decision. It has since recovered somewhat to trade 13 percent lower at 1.04 francs.

It wasn't just the euro that got caught up in the franc's frenzied moves. The dollar plunged by a similar amount, though it also recouped some of its kneejerk losses to trade 15 percent lower 0.8884 francs.

"Switzerland suddenly got a whole lot more expensive," said Michael Hewson, senior market analyst at CMC Markets.

Many analysts thought the decision was inevitable in light of next week's expected announcement by the ECB to break new ground in its efforts to inject life into the ailing 19-country eurozone economy. Its stimulus package is expected to be worth as much as 1 trillion euros ($1.17 trillion).

"The first thing it says is that the SNB clearly expected to see a huge surge of inflows in the week ahead and saw little reason to provide these buyers of francs with an artificially cheap rate," said Simon Derrick, chief currency strategist at BNY Mellon.

The Swiss central bank argued that the "exceptional and temporary" measure to protect the Swiss economy was "no longer justified."

The peg, which was introduced in Sept. 2011, was an attempt to halt the rise of the franc — a traditional haven currency for investors — against the euro at a time when the eurozone debt crisis was at its height. The strong franc was then particularly problematic for Swiss exporters, who were forced to drastically cut prices to remain competitive.

Unsurprisingly, Thursday's move prompted a painful 11 percent drop in Switzerland's stock market as investors took fright at the worsening outlook for Switzerland's traditional exporters, such as those selling chocolate or ski holidays.

And as in the eurozone, there's a growing fear that the country will suffer a sustained period of falling prices, or deflation. A stronger currency makes imports cheaper, further dampening inflation — in the year to December, prices fell 0.5 percent.

In an effort to contain the franc's future appreciation and limit any damage to the Swiss economy, the central bank also lowered a key interest rate — what it charges commercial banks to deposit at the bank — to minus 0.75 percent from minus 0.25 percent. The hope is that it dissuades banks from parking their cash at the national bank, opting instead to invest in the Swiss economy.

However, many analysts think the franc will continue to rise. The currency often gets bought up in times of global uncertainty, and that's not going to change easily. The franc's value will remain sensitive to developments around the world, including the crisis in Russia and the oil market slump.

In a press conference following the decision, the Swiss central bank's president, Thomas Jordan, laid out the hope that the "huge overvaluation" of the franc will not persist long.

"We assume that this situation will correct itself," he said. "What we are now observing is a clear exchange rate overshoot — thefranc is clearly overvalued at these levels."

The Swiss trade union federation, SGB, warned that the central bank's decision could cost jobs and weigh on salaries.

"An uncontrolled rise (of the franc) can be expected," the SGB said in a statement. "Exporters (industry/tourism) that are already suffering from the overvalued franc feel further pressure."