Swiss central bank will struggle to break its interventionist habit

The writer is an FT contributing editor

In a crowded field of central bank monetary experiments, Switzerland’s efforts stand out as particularly wild. The Swiss National Bank now finds itself with an outsized balance sheet and no easy way to unwind it.

Like other central banks, the SNB expanded its balance sheet to ward off the spectre of deflation. Unlike developed market peers, it did so by selling freshly created electronic money into foreign exchange markets and investing the proceeds in global stocks and bonds. This is no small point of difference.

To understand how the central bank got here, we need a little history. Switzerland has run large current account surpluses for decades. Current account surpluses are associated with currency strength unless residents recycle them into foreign assets. Until the global financial crisis this is exactly what the Swiss did. But since then, a desire to bring home profits has contributed to persistent currency strength. The result has been profoundly disinflationary.

The SNB responded first by cutting interest rates, then in 2011 by introducing a currency floor against the euro. The floor required frequent small-scale interventions in the foreign exchange market. But in 2015 the governing council lost their nerve. Perhaps spooked by the prospect of tying their fortunes to the European Central Bank as it embarked on quantitative easing, they abandoned the floor with chaotic results. The Swiss franc rallied almost 40 per cent intraday. Seven and a half years of negative interest rates followed.

Serial central bank interventions persisted with the sale of freshly minted electronic Swiss francs in an effort to avoid the deflationary implications of steadfast currency strength. These interventions inflated the SNB’s balance sheet to a peak of around 140 per cent of GDP.

While many other central banks are now passively winding down their balance sheets by letting bond holdings mature, the Swiss are stuck. The two most obvious options to shrink their portfolio are unappealing: make dud investments or actively unwind it.

Critics will point to 2022 as evidence that the SNB needs no lessons in losing money. In a year when international bond and stock values dropped and the Swiss franc appreciated, the central bank recorded a loss equivalent to 17 per cent of GDP. In fairness, it’s not easy for the Swiss to create anything but a huge carry trade out of their reserves. And this will always get hit hard by a flight to quality. The portfolio’s vulnerability to further loss is one reason behind calls to actively wind it down.

But unwinding the carry trade means selling foreign currency to buy back Swiss francs. And bidding up the franc’s value is deflationary. Even over the course of the biggest inflation shock since the 1970s they managed to sell less than a quarter of the portfolio. With core inflation now down to only 1.1 per cent and a medium-term forecast in the same ballpark, a full unwind would likely push the economy back into outright deflation.

If winding down is unappealing, what are the other options?

First, the central bank could transfer the reserves to Swiss citizens. The SNB has, after all, merely been recycling national current account surpluses into claims on foreigners — something the Swiss people happily did until the global financial crisis. Transferring these in a citizens’ dividend would put the assets back into private hands.

More widely discussed is a prospective transfer of reserves to a new sovereign wealth fund. As things stand, the SNB implements a passive investment policy, but its returns have lagged behind international benchmarks. Since 2009, the foreign currency reserve portfolio has delivered an average return of only 0.4 per cent a year. Professionalised management could help deliver higher returns with which to fund government priorities.

Neither option addresses what should be done about any future currency strength. With rate cuts unlikely to move the dial, and capital controls unthinkable, the choice is between further intervention and genuine free float. In 2020 the US Treasury — rightly — labelled Switzerland a currency manipulator, putting diplomatic pressure on the SNB to desist. But Maxime Botteron, an economist at UBS, tells me that the implications for Switzerland were limited and didn’t stop the SNB from further purchases in 2021.

In October, Martin Schlegel will succeed Thomas Jordan to become the SNB’s governing board’s new chair. Market jitters have pushed the franc to fresh highs, but data suggests the central bank has been largely absent from markets. It’s unclear whether Schlegel will allow the market to set the franc’s value or follow his mentor’s impulse to intervene. Neither option is without peril.

Letters in response to this article:

Why Swiss citizens face a potential double whammy / From Antonio Foglia, Vice-president, Ceresio Investors Group, Lugano, Switzerland

Contradictions at heart of Swiss central bank policy / From Jacob Bjorheim, Reader, Faculty of Business and Economics, University of Basel, Switzerland

Interventionism is Swiss central bank success story / From Freddie Hasslauer, Zurich, Switzerland