Switzerland Caps Franc

The Wall Street Journal

By DEBORAH BALL

LONDON—The Swiss National Bank set a limit on how far it will let the Swiss franc rise against the euro, the bank's most aggressive attempt yet to rein in the soaring currency.

The SNB said it would buy euros in "unlimited quantities" should the single currency fall below 1.20 francs, setting the stage for what could be a long battle by the bank to defend its action in the face of surging concerns about debt problems in the euro zone and the U.S.

The SNB said Tuesday that it would "no longer tolerate" the euro falling below the minimum rate. In a statement, it said it will enforce the limit with "the utmost determination and is prepared to buy foreign currency in unlimited quantities."

The euro surged 10% to 1.22 francs on the news. Prior to the news, the euro had sunk to about 1.10 francs, after hitting a record low of 1.001 francs in early August. The Japanese yen also weakened, as investors wondered whether the Japanese central bank—which intervened early last month to rein in the Japanese currency—might follow the Swiss.

U.S. stock market futures were pointing to losses for Wall Street Tuesday morning, as investors face European turmoil and lingering disappointment over last week's jobs data.

Even gold, which has hit repeated highs this summer, lost some of its safe-haven shine, falling 2% early in the European day.

In its first comment on the Swiss bank's efforts to rein in the franc, the European Central Bank said it took note of the decision to set a floor against the euro. In August, ECB President Jean-Claude Trichet urged countries to intervene in currency markets in tandem, rather than going it alone.

In August, the SNB slashed interest rates to close to zero and flooded the market with liquidity in an effort to pull down a franc that has threatened to choke off Swiss growth. The franc gained 27% between November 2010 and early August against the euro, with investors viewing Switzerland—with its strong growth and solid public finances—as a haven from the euro zone's festering debt crisis.

The SNB's August moves helped drive the euro nearly 20% higher against the franc, but in recent days a deteriorating outlook for the global economy and the euro zone had sent the franc higher again. That may have prodded the SNB to take further action, say foreign-exchange strategists.

The relentless strength of the franc has already pushed some weaker Swiss exporters into bankruptcy, and sent others scrambling to slash prices to hold onto business. Swiss export prices fell 6.2% in the first half of the year. The Swiss government expects 1.5% gross national product growth in 2012, down from 2.1% this year and 2.7% last year.

For the last month, the Swiss government and business leaders have been appealing for bolder action by the SNB to weaken the currency, particularly amid signs that growth elsewhere in Europe and in the U.S. could hit the skids. In its Tuesday statement, the SNB said the franc "poses an acute threat to the Swiss economy."

Having drawn a line in the sand, the SNB could now face an endurance test in defending its euro-franc limit, as investors increasingly worry whether key euro-zone members such as Italy will execute a credible plan to get their enormous debts under control.

Recent experience isn't encouraging. When the franc began surging in early 2009 in the early days of the euro-zone crisis, the SNB regularly intervened to buy euros. But it abandoned the effort in June 2010 in the face of widespread criticism. Between March 2009 and June 2010 the euro fell from 1.48 francs to 1.32 francs, and the SNB posted 2010 exchange-rate losses of 32.7 billion francs. The losses sparked calls for SNB President Philipp Hildebrand to resign.

This time, the SNB will be fighting a sharp slowdown in the U.S. economy as well as the deep debt crisis among its euro-zone neighbours, in particular Italy. The ECB recently warned Rome that it may not be doing enough to get its debt under control, and a general strike Tuesday in Italy highlighted the difficulty of reforming public finances there.

"This could be a bloody battle for the SNB over the next few months," said Jane Foley, currency strategist for Rabobank. "It's a battle of the SNB against the search by investors for safe havens."

Others point to the strong language in the SNB's Tuesday statement as a sign of the bank's determination, which could bolster its credibility in the market. The language is far starker than the bank's communiqués to the market during its 2009-2010 interventions.

"The SNB is now completely committed," said Alessandro Bee, currency strategist with Bank Sarasin. "There is no going back. They will do everything to defend this. They have to resist the pressure. Otherwise, they can just close the SNB."

Mr. Bee expects the euro to stay quite close to the 1.20-franc level in the coming months, and then appreciate to around 1.30 francs next year if the euro-zone debt problems ease.

Should the SNB have to intervene for years, it could risk driving up inflation. But economists see virtually no short-term risk of rising prices; Swiss inflation has been around 0.5% over the last year. Instead, if the SNB posts further losses due to currency intervention, it could cause tensions with the local leaders of Switzerland's 26 cantons, which traditionally have received a large portion of the central bank's profits. However, early comments from politicians in Bern were supportive of the SNB's move.

Meanwhile, Swiss business welcomed the news, although some said a euro-franc exchange rate of 1.20 still leaves them under pressure.

"We think a fair value would be 1.30 to 1.40 francs, but taking into account the serious debt crisis in Europe and the problems in the U.S., we believe 1.20 francs is a level that can be easily defended," said Rudolf Minsch, chief economist for Swiss business lobby Economiesuisse in an interview. "There is a trade-off in order to convince the market that this level is defensible."

Write to Deborah Ball at deborah.ball@wsj.com