'Nuclear option'

The Swiss National Bank (SNB) announced Tuesday it would "no longer tolerate" an exchange rate below the minimum of 1.20 francs per euro with immediate effect, and would enforce this minimum rate by purchasing foreign currency in "unlimited quantities."

The central bank is exercising what many analysts in recent weeks had called the last-ditch "nuclear option" because of the uncertain effects and risks to the normally strong Swiss economy.

"The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development," the SNB said in a statement that described its goal as "a substantial and sustained weakening of the Swiss franc."

The euro, which had been trading around 1.10 francs before the announcement, shot up to 1.2024 francs afterwards.

Last ditch

The SNB said even the rate of 1.20 francs per euro was too strong and "should continue to weaken over time." It added that it was prepared to take further measures to make that happen.

The Swiss franc, considered a safe haven currency, has been rising throughout the year as investors flee economic turmoil in the US and Europe. At its peak earlier in August, the franc was up about 20 percent against the euro and 25 percent against the dollar compared to 2009.

Swiss exporters have been fretting over the rise of the franc in recent months, complaining that high prices were beginning to have a negative impact on their businesses.

Averting a worse crisis

Tobias Knedlik, currency expert at the Halle Institute for Economic Research (IWH), underlines that this says more about Swiss fears than it does about the ongoing debt crisis in the eurozone.

"The rising value of the franc had a strong effect on the Swiss economy," he told Deutsche Welle. "Exports from Switzerland became more expensive in comparison to imports, which meant native products could not be sold anymore - neither domestically nor internationally. We know all the stories about how Swiss people started to go shopping over the border in Germany."

Knedlik also says that while banks rarely like to intervene in the currency markets, there are no major risks for Switzerland. "The measure should really minimize risks," he said. "Of course, whenever you control exchange rates, you make yourself somewhat dependent on international developments. Fixing the exchange rate means that you are forcing the domestic market to adapt - but that is exactly what is wanted in this case."

Other dangers

Henning Vöpel of the Hamburg Institute of International Economics also thinks the decision was to be expected. "I don't it's really such a dramatic development," he said. "The pressure on the Swiss economy was of course immense."

"Interventions in the currency market do happen every now and again," Vöpel added. "It's more unusual to fix a flexible exchange rate, but in this case it's justified, given the special circumstances in the eurozone at the moment."

Vöpel says that the Swiss franc has now become a more or less risk-free investment. "What could happen is that the SNB can't hold the exchange rate and the currency revalues, which is of course good for people with Swiss francs," he said.

But there are risks for the SNB. "The quantity of money will of course drastically increase," said Vöpel. "That means that the prices for goods and services could still rise in Switzerland – but in the short-term this was a justified measure."

Cut lending

The exchange rate cap comes after the central bank cut lending rates to almost zero and launched three rounds of liquidity injections in August to cool demand for the franc - with little impact.

The Swiss government said on August 17 it would spend 2 billion francs to counter the impact of the exchange rate on the domestic economy.

Author: Ben Knight
Editor: Sam Edmonds