News analysis: Swiss central bank's unexpected lifting of currency cap jolts market

Thursday's surprising announcement from the Swiss National Bank (SNB) about its lifting a three-year-long cap on the Swiss franc jolted the global market, as the black swan event sent the Swiss franc surging against the euro and dollar and dampened the equities market.

UNEXPECTED DECISIONS

In light of the safe-haven allure of the Swiss franc, the Swiss central bank has set and then defended the minimum exchange rate of the Swiss franc at 1.20 per euro since September 2011, amid the eurozone's debt crisis, in a bid to shield from deflation, discourage investors to swarm to the Swiss franc and prevent the overvaluation of its currency.

Over the past three years, SNB has repeatedly highlighted its determination to enforce the ceiling through a massive purchase of euros in unlimited quantities, and the latest official reiteration was heard in its monetary policy announcement released weeks ago.

Such a policy cornerstone made Switzerland one of the world's biggest buyers of the euro even in a dimming scenario of the official currency of the eurozone.

But in stark contrast to the common prudent practices by other central banks, SNB acutely shifted its longstanding policy in an unexpected and uncharacteristic move on Thursday, stunning traders, analysts, and businesses.

In the wake of this announcement, the Swiss franc surged against euro as much as 40 percent and soared against the U.S. dollar as much as 30 percent. Such a fluctuation could rank among the most acute ones in recent years.

In addition, Swiss Market Index, the country's vital stock market index, plunged as much as 14 percent due to concerns over possibly shrinking profits earned by major export-oriented companies.

The stocks of Switzerland's largest watchmaker, Swatch Group, with renowned brands Omega and Longines; the leading Swiss dealer of luxury goods Richemont that owns Vacheron Constantin, Cartier and Montblanc; and Swiss leading pharmaceutical company Novartis all plummeted, and the average decline margin was around 10 percent.

DE-BINDING IN PARALLEL WITH DEEPENING NEGATIVE INTEREST

The chairman of SNB, Thomas Jordan, defended his bank's sudden new decisions and declined to comment whether SNB spoke to other central banks about its sharp turn in policy, saying that surprise was necessary, and the price of the Swiss franc would decrease to a stable level over time.

But analysts did not see eye to eye with the top Swiss monetary policy-maker, arguing that a central bank should play a stabilizing role rather than swooping on the market, otherwise its credibility would be compromised.

Under the new decisions, the SNB would abandon the minimum exchange rate and cease euro purchases. The central bank said "enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified" given the considerable depreciation of the euro against the U.S. dollar, and the subsequent weakening of the Swiss franc.

Meanwhile, the SNB is lowering the interest rate on sight deposit account balances that exceed a given exemption threshold to negative 0.75 percent.

Such a move is designed to discourage investors from holding large deposits in Swiss francs, prevent a highly-possible capitals inflow, and avoid the overvaluation of its currency.

Jordan said that to further scale down the negative interest rate was a "strong instrument" that would "increasingly show its effect."

He also noted that de-binding the Swiss franc and euro did not mean SNB was switching its currency's value to the dollar, but rather was looking at the overall exchange rate against all currencies.

Jordan reiterated that the SNB would continue to pay close attention to the foreign exchange market, and if necessary, would intervene.

TIMING DREW ATTENTION

SNB's change in policy increased the speculation that the European Central Bank (ECB) would unveil a bond-buying program, as analysts noted.

A day before the bank's announcement, Mario Draghi, ECB president said the ECB was determined to purchase government bonds, which was believed to be a strong signal for the qualitative easing (QE) program to kick off.

Speculations about an announcement of the government bond purchase at a governing council meeting scheduled on Jan. 22 are running high.

With deflation in the eurozone looming as the economy falters once again, the QE rescue plan was highlighted by Draghi as a major option to boost the feeble growth in euro area.

On the other hand, the unclear outlook of the Greek election and its potential default, or departure from the 19-nation currency bloc, further shakes the confidence in the euro's stability given the single currency's recent fall.

Under such a context, the Swiss central bank's move showed that it would not go down with the euro, as well as indicating a high level of uncertainty in the eurozone, analysts said.

This puts pressure on equities, pushing investors toward buying safe haven assets such as gold and German bonds. Take gold futures as an example: gold futures on the COMEX division of the New York Mercantile Exchange jumped on Thursday to a more-than-four-month high as investors weighed Switzerland's unexpected move to abandon the three-year cap. Endit