There was more talk of the potential CHF peg over the weekend with local press (SonnatsZeitung) reporting ‘intense’ talks and a possible announcement later this week. The newspaper mentioned 17 August as the day where an ‘appropriate plan’ could be announced. Over the past week we have outlined the various flaws of introducing a peg like system for the CHF. Also, we have outlined IF a peg were to be announced, it would make more sense that it be close 1.30 – back to March levels when the CHF overshoot began but there are vague reports of a EUR-CHF floor near 1.10. It is worth noting that the Swiss authorities had been down this road before, temporarily moving away from monetary targeting to focus on FX instead. This was back in October 1978 where a floor for DEM-CHF was introduced. But this ultimately had undesirable consequences whereby inflation skyrocketed, reaching over 7.0% in 1981. Not great for a central bank that is meant to be focused on price stability.
The Swiss authorities will remember the experiences of the late 1970s and such a fight against CHF strength was difficult. Furthermore the problems the Swiss faced back then are somewhat similar to today. That is, the CHF strength back then was partly a function of lax US monetary policy and a weak USD – sound familiar?
The upward pressure on the CHF only started to fade when the US in particular started to fight back against inflation. This should serve as a reminder that if the Swiss go down the same path as before, its concern over the CHF will not truly dissipate until the world outside Switzerland looks like a better place. The past shows that there were high costs associated with a temporary move towards targeting the exchange rate.
It’s amazing that this time last week we were focused on the implications of a US downgrade and by middle of last week, Switzerland got all the focus.
HSBC Global Research