Strong Swiss currency: Top 7 points about the new Swiss franc peak

Interest rate expectations are very important in price fluctuations. If interest rates on a currency such as the euro are expected to fall more sharply than on another currency such as the franc, then the euro will become less attractive as an investment currency compared to the franc. As a result, more francs are purchased and less euros are purchased, causing the franc to appreciate against the euro.

For example, central banks in the US and Europe have increased key interest rates much more than the Swiss National Bank (SNB) due to very high inflation. As a result, market interest rates there also rose rapidly. Given the significant decline in inflation, the market is now driven by expectations that the US Federal Reserve and the European Central Bank (ECB) will cut interest rates again in several steps next year. The base interest rate in Switzerland is also significantly lower, as inflation in Switzerland has always been significantly lower than abroad and is currently at 1.4 percent, which is within the SNB’s comfort range of under 2 percent. It is currently 1.75 percent, 5.5 percent at the Fed (the top of the target range) and 4.5 percent at the ECB (the main refinancing rate).

As a result, the Federal Reserve has both less opportunity and less need than the United States or the Eurozone to significantly reduce interest rates in the future. The expectation that interest rates in these two currencies will fall more sharply than in Switzerland makes the franc more attractive as an investment currency compared to the euro and dollar.

For decades, financial investments in Switzerland have had a reputation as a safe haven; because Switzerland is considered particularly stable and inflation has almost always been lower than in other countries, including in recent years. Therefore, the franc exchange rate has become an indicator of uncertainty in world markets.

In case of major conflicts and therefore increased risks to the global economy, investors invest their money in Swiss Franc investments for security purposes, which leads to its appreciation. Growing concerns about the ongoing war in Ukraine and the expansion of the conflict in Israel, as well as other rising geopolitical and economic risks, have tended to strengthen the safe-haven function of the franc in recent times.

As in all markets, all causes (such as those mentioned in the first and second points for the Swiss franc) have an increasing effect on the price when there is less trading or fewer people are involved in trading. This is later referred to as the “weak trade”.

For example, if there are fewer interested parties in a sell order, the sale is more likely to occur at a lower price than if more people are involved. Currency trading during holidays is also “weak” in this sense, because the majority of traders do not work – so there are always particularly noticeable price fluctuations on such days.

The record value of the Swiss franc exchange rate, which we mentioned at the beginning, refers only to the euro. This is of great importance for Switzerland, given its very close economic relations with the Eurozone. But the dollar has enormous weight, not only because of trade with the United States, but also because it dominates the international financial and trading system even if it has no direct connection to the United States. Most prices for raw materials and many other goods are in dollars, and some large Swiss companies report their figures in US currency.

The franc has also appreciated significantly against the dollar recently. At the beginning of October, the price of the US currency was above 92 centimeters, but at the beginning of the year it fell below 84 centimeters. However, unlike the euro, this is not a record value. At the height of the euro crisis in the summer of 2011, a dollar cost just over 70 cents. But the long-term appreciation of the franc is also evident in the US currency: at the beginning of the millennium it was still necessary to pay 1.80 francs per dollar.

The explanations for the recent appreciation for the dollar are the same as for the euro, with interest rate expectations predominant. Expectations that the Fed would lower interest rates caused the dollar to weaken against all major currencies.

But the development of nominal exchange rates is not enough to decide whether purchases from abroad are more or less valuable or whether exporters are losing competitiveness. The development of prices in the field of foreign exchange is also very important. For example, if inflation in the euro area increases at the same rate as the value of the franc against the euro, nothing will change in price conditions. In this case, the price difference of European goods is completely compensated by the cheap euro.

In fact, inflation in both the Eurozone and the USA has been much higher than inflation in Switzerland in the last two years. This has also become less obvious over the last few decades. In real terms – if you take price developments into account – the franc has not reached its all-time high and the overall upward trend has been put into perspective over the last few decades. According to data from the Swiss National Bank, the external value of the franc against the euro is currently at the same level as in the summer of 2022, despite the nominal appreciation since then.

Looking at real exchange rate changes puts into perspective the dramatic increase in the value of the franc over the last few years and decades. However, while recent price increases are good news for those buying from abroad, it is especially bad news for Swiss companies that export their products abroad.

Very rapid and severe appreciation increases are stronger than the change in sales prices. Companies are also less able to absorb these through efficiency and cost measures to remain competitive. Because this takes time. However, in the long run, the appreciation of the franc proved to be an excellent adjustment program for the Swiss export industry.

What makes the problem worse is that the future for exporters is not bright, regardless of the Swiss franc exchange rate. There is an economic crisis in Europe and especially in Germany, the most important export country for Swiss companies, and this puts pressure on demand.

This is especially felt by the Swiss industry. The order situation is weak and there is no improvement in the purchasing managers’ index, the most important leading indicator of the sector. It rose only slightly from 42.1 points to 43 points in December, and thus remained below the 50 growth threshold for a year. The franc is now also appreciating at a “dramatic pace”, according to Swiss technology industry association Swissmem. This situation poses a serious threat to competitiveness.

As is already clear in the first point, central banks’ base interest rates are vital for the nominal exchange rate. This also applies to the Swiss National Bank. However, it also directly affects the exchange rate of the franc through the buying and selling of foreign currencies, i.e. foreign currencies.

The nominal increase in the foreign value of the franc over the last two years has been welcomed for two reasons: first, it has had the effect of slowing down the rise in prices of imported goods. This situation also slowed down the rise of inflation in Switzerland. The latter made it possible for the SNB to sell some of its huge foreign exchange reserves, causing its balance sheet to rise to over 1 trillion francs by May 2022. Since then, the SNB’s balance sheet size has fallen to 785 billion.

How the Central Bank will react to the latest appreciation remains an open question. In any case, the latest data on banks’ current deposits with the SNB do not indicate that banks are intervening again in foreign exchange markets.

If it buys foreign currency, banks’ current deposits will increase as a result of the purchases. However, according to the latest figures on December 29, they are in decline. Additionally, markets currently expect the SNB to cut its key interest rate next year. However, if the external value of the franc continues to increase significantly, it may make a different decision and buy foreign currency again.