160908 switzerland

Switzerland Watch

Group Economics Macro & Financial Markets Research

08 September 2016

Why continue FX interventions?  Swiss FX reserves have risen again...

Georgette Boele Co-ordinator FX & Precious Metals Strategy Tel: +31 20 629 7789 georgette.boele@nl.abnamro.com

 …because of a valuation effect and FX interventions  Meanwhile, the economy has picked up strongly…  …mainly driven by higher exports  There is less need to continue FX interventions…  …but the SNB will likely continue as long as CPI is close to zero  Positive investor sentiment and no step-up of pace of ECB QE…  …will likely result in a slightly weakening of franc A rise in FX reserves again…

Yesterday morning the August preliminary Swiss National Bank (SNB) foreign exchange reserves were released. They came in above expectations at CHF 626.62bn, which was a considerable increase from CHF 615.55 bn in July. The increase can be the result of valuation effect and/or the result of the selling of Swiss franc in currency markets.

According to our calculations, taking into account the composition of these reserves, more than half of the CHF 11bn increase came from valuation effects. As the euro (41% of the FX reserves), US dollar (34%), sterling (7%), yen (8%) and Canadian dollar (3%) appreciated versus the Swiss franc during August, there was an increase in FX reserves denominated in Swiss franc (accounting for around 60% of the rise). In addition, roughly 40% of the increase in FX reserves appears to be the result of FX intervention.

Reserve composition FX composition in % USD 34.0 USD/CHF EUR 41.0 EUR/CHF GBP 7.0 GBP/CHF JPY 8.0 JPY/CHF CAD 3.0 CAD/CHF

27-Jul-16 0.9695 1.0832 1.2823 0.00950 0.7439

31-Aug-16 0.9826 1.0963 1.2911 0.00951 0.7486

Source: Bloomberg (FX), Reserve composition SNB Q2 2016

Since 2010, the foreign exchange reserves at the Swiss National Bank have risen substantially to approximately 97% of GDP. Last year, the SNB abandoned the floor in EUR/CHF. One of the reasons was that FX reserves would otherwise rise too sharply and become too large as compared to GDP. However, shortly after abandoning the floor, FX reserves have risen substantially again (see graph below) reflecting intervention in

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Switzerlan nd Watch - Why W continu ue FX interve entions? - 08 0 Septembe er 2016

currency markets to d dampen the im mpact of the strong franc on thhe economy an nd valuation effects s.

Foreiign exchange e reserves co ontinue to rise e In bn CH HF

700 600 500 400 300 200 100 0 00

02

04 4

06

08

10

12

14

16

Source: Bloomberg

…aga ainst the back kground of a strong pickup in the econ nomy…

Switze erland is a sma all open econom my that is highly dependent oon exports. Exp ports are 74% of GDP and nett exports accou unt for roughly 15% of GDP. N Next to exports s, private consum mption is also a an important contributor to GDP. Recent GD DP data show that the Swiss economy has performed stro ongly this year. Economic groowth in the seco ond quarter came in at 2.0% yoy which was far above market consensus of 0.8%. The main contrib butor to the stro onger economiic growth has been b exports (ssee graphs below).

Ec conomic grow wth has surprised on the upside in Q2 … %

…mainly because of strong exp ports %

6 5 4 3 2 1 0 -1 -2 -3 -4 -5

15

6

10

4 2

5

0 0

-2

-5

-4

-10

-6 4 05 06 07 08 0 09 10 11 12 13 14 15 16 04

00

02

04 GD DP % yoy

06

08

10

12

14

P Private consumption % yoy

Sou urce: Bloomberg, A ABN AMRO Group Economics

16

N exports, contrib Net bution to GDP grow wth (lhs)

GDP P, % yoy (rhs)

Source: Bloomberg, B ABN AMRO A Group Econnomics

During g the months fo ollowing the sha arp appreciatio on of the Swisss franc (last yea ar), signs of a cons siderable future e drop in Swiss s exports emerg ged. In the endd, the impact on exports was modest, m mainly b because Swiss s exporters low wered their price ces as well. The e graph below shows that the ere is a tendency to adjust prices in reactionn to a strengthe ening Swiss kened and expo ort prices havee increased with a lag of franc. Recently, the ffranc has weak d 3 months. around

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Switzerlan nd Watch - Why continu ue FX interve entions? - 08 0 Septembe er 2016

Expo ort prices follo ow the franc with a 3-mon nth lag % yoy export e prices

CHF (inverse scale)

15 5

-15

10 0

-10 -5

5

0

0

5

-5 5

10

-10 0

15

-15 5

20 00

02 04 4 06 08 10 Export priices 3 months delay (lhs)

12

1 14

16

Calculated d effective exchang ge rate Switzerland d (rhs) Source: BoE, Bloomberg , ABN AMRO Gro oup Economics

…but deflationary forces are sttill present Deflationary pressure es are still pres sent. Consume er price inflationn is rising gradually ds zero, while ccore inflation yo oy is zero. Swiss single familyy house prices s are rising toward but at a considerablyy slower pace than some years ago. On the other hand, th he ployment rate h has been stable e at 3.3% for some months nnow. The overa all picture is unemp some cooling c in the h housing market, a stabilisation in the labourr market while consumer c price in nflation is sligh htly picking up.

Cons sumer prices are rising gra adually % yoy CPI C

2 1 0 -1 -2 10 0

11

12

13 CPI

14

15

16

Core CPI

Source: Bloomberg

Why continuing c bu uilding up FX X reserves?

The main question w we ask ourselve es is the followiing: does the ccurrent state of the economy justify FX in nterventions? We W are inclined d to say “no”. F First of all, the Swiss S franc remain ns in overvalue ed territory in no ominal terms, while w Swiss exxports are neve ertheless doing relatively well. The flexibility to t adjust exporrt prices with a lag to develop pments in the franc is s an important reason for this s. It looks like the private secttor has shown more resilien nce than that w was expected in nitially. Second d, if the vast am mount of FX res serves was an imp portant reason to abandon the e floor in EUR//CHF on 15 Jannuary 2015, it is surely a good reason r to stop building up foreign exchange e reserves now w. However, defflationary forces continue to be e an important reason to continue the currennt monetary po olicy mix. As a CPI (core an nd headline) start to move convincingly abovve zero again and the soon as labourr market contin ues to stabilise e, we think thatt there is less inncentive to inte ervene unless s a wave of sha arp risk aversio on were to occu ur. In an enviroonment of more constructive investorr sentiment and d no step-up in the pace of EC CB monetary policy p

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Switzerlan nd Watch - Why W continu ue FX interve entions? - 08 0 Septembe er 2016

easing g, the franc will likely slowly weaken w on its own. We foreseee a modest de epreciation of the Sw wiss franc this yyear and next year. y Our new year-end targeet for 2016 and 2017 in EUR/C CHF are 1.10 (ffrom 1.09 prev viously) and 1.14 (1.12 beforee), respectively. However, we exp pect the SNB to o keep negativ ve rates in place as long as thhe ECB continu ues monetary policy easi ng.

SNB 3-Month Libo or Target Ran nge to remain n negative %

5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 0 01 02 03 04 00 4 05 06 07 08 09 10 11 12 13 1 14 15 16 Libor Lower Target T Rate Middle Rate

Libor Upper Target Rate

Source: Thomson Reuterrs Datastream

nd out more abo out Group Eco onomics at: http ps://insights.a abnamro.nl/en n/ Fin

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