Swiss scrap upper limit on franc, cut Libor target 50 bps

    Switzerland's central bank scrapped its cap on the exchange rate of the Swiss franc against the euro and slashed the rate on large bank deposits and its benchmark 3-month Libor rate by a further 50 basis points to minus 0.75 percent, saying that "enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified."
    The Swiss National Bank (SNB) - which introduced the 1.20 euro cap on the franc's exchange rate in September 2011 at the height of Europe's sovereign debt crises when safe-haven inflows pushed up the franc's exchange rate and threatened its exports - said the recent depreciation of the euro against the U.S. dollar had also caused the franc to weaken against the dollar.
    "Recently, divergences between the monetary policies of the major currency areas have increased significantly - a trend that is likely to become even more pronounced," the SNB said, an apparent reference to next week's meeting by the European Central Bank (ECB) that is expected to lead to full-scale quantitative easing through the purchase of euro zone government bonds.
   "While the Swiss franc is still high, the overvaluation has decreased as a whole since the introduction of the minimum exchange rate," the SNB said in a statement that took financial markets by surprise, triggering an immediate jump in the franc's exchange rate against the euro to 1.15 from 1.20 and to above parity against the U.S. dollar of 0.99 compared with a rate of 1.02 before the news.
    The move by the SNB comes less than a month after it imposed the negative rate of 0.25 percent on large bank deposits to make it less attractive for investors to hold Swiss franc investments and thus ease the upward pressure on the franc.

    The rate cut announced in December was scheduled to take effect on Jan. 22, the date of the ECB's council meeting. Today's rate cut and scrapping of the franc's limit takes effect immediately.
    Today's interest rate cut is carried out to help ensure that the expected rise in the franc's exchange rate doesn't lead to "an inappropriate tightening of monetary conditions," the SNB said.
    The franc has been facing growing pressure in recent months from safe-haven inflows in connection with Russia's economic crises and from euro zone investors who are expecting the ECB's expanded stimulus to trigger further depreciation of the euro. Since May 2014 the euro has plunged almost 16 percent against the U.S. dollar, trading around 1.17 today from 1.39.
    The upward pressure on the franc has forced the SNB to intervene heavily to defend its exchange rate target. It is estimated to have bought some 20 billion euros in December with its currency reserves rising to 495.1 billion francs at the end of December from 462.7 billion in November.
    In addition to removing its limit on the franc's exchange rate - which the SNB last month described as "the key instrument" to avoid a higher franc leading to tighter monetary conditions - the Swiss central bank also softened the language it used to describe how it would operate in currency markets.
    In recent years, the SNB had often said it would enforce its exchange rate target with "utmost determination."
    Today it said it would "continue to take account of the exchange rate in formulating its monetary policy" and "if necessary, it will therefore remain active in the foreign exchange market to influence monetary conditions."

    The Swiss National Bank issued the following statement:

The Swiss National Bank (SNB) is discontinuing the minimum exchange rate of CHF 1.20 per euro. At the same time, it is lowering the interest rate on sight deposit account balances that exceed a given exemption threshold by 0.5 percentage points, to −0.75%. It is moving the target range for the three-month Libor further into negative territory, to between –1.25% and −0.25%, from the current range of between −0.75% and 0.25%.
The minimum exchange rate was introduced during a period of exceptional overvaluation of the Swiss franc and an extremely high level of uncertainty on the financial markets. This exceptional and temporary measure protected the Swiss economy from serious harm. While the Swiss franc is still high, the overvaluation has decreased as a whole since the introduction of the minimum exchange rate. The economy was able to take advantage of this phase to adjust to the new situation.
Recently, divergences between the monetary policies of the major currency areas have increased significantly – a trend that is likely to become even more pronounced. The euro has depreciated considerably against the US dollar and this, in turn, has caused the Swiss franc to weaken against the US dollar. In these circumstances, the SNB concluded that enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified.
The SNB is lowering interest rates significantly to ensure that the discontinuation of the minimum exchange rate does not lead to an inappropriate tightening of monetary conditions. The SNB will continue to take account of the exchange rate situation in formulating its monetary policy in future. If necessary, it will therefore remain active in the foreign exchange market to influence monetary conditions. 

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