The Swiss central bank will struggle to break its interventionist habit

Unlock Editor’s Digest for free

FT editor Roula Khalaf selects her favorite stories in this weekly newsletter.

The writer is a contributing editor to the FT

In a field crowded with central bank monetary experiments, Switzerland’s efforts are particularly wild. The Swiss National Bank now finds itself with an overstretched balance sheet and there is no easy way to unlock it.

Like other central banks, the SNB has expanded its balance sheet to ward off the specter of deflation. Unlike its developed market counterparts, it has done so by selling newly created cryptocurrency on foreign exchange markets and investing the proceeds in global stocks and bonds. This is not a small point of difference.

To understand how central banking 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, that’s exactly what the Swiss did. But since then, the desire to bring home profits has contributed to the currency’s steady strength. The result was profoundly disinflationary.

The SNB responded first by cutting interest rates, then in 2011 by introducing a foreign exchange ceiling against the euro. The floor required frequent small-scale interventions in the foreign exchange market. But in 2015, the board lost its nerve. Perhaps spooked by the prospect of tying their fortunes to the European Central Bank as it began quantitative easing, they abandoned the floor with chaotic results. The Swiss franc rose nearly 40% on the day. Seven and a half years of negative interest rates followed.

Mass interventions by central banks continued with the sale of newly minted electronic Swiss francs in an effort to avoid the deflationary implications of the currency’s constant strength. These interventions swelled the SNB’s balance sheet to a peak of approximately 140% of GDP.

While many other central banks are passively liquidating their balance sheets by letting bond holdings mature, the Swiss are stuck. The two most obvious options for shrinking one’s portfolio are unappealing: make the wrong investments or actively wind it up.

Critics will point to 2022 as proof that the SNB needs no lessons in losing money. In a year when international bond and stock values ​​fell and the Swiss franc appreciated, the central bank posted a loss equivalent to 17% of GDP. In all fairness, it’s not easy for the Swiss to create anything other than a huge shipping exchange from their reserves. And this will always be hit hard by a flight to quality. The portfolio’s vulnerability to subsequent losses is one of the reasons behind calls to actively reduce it.

But clearing the carry means selling foreign currency to buy back Swiss francs. And the rise in the value of the franc is deflationary. Even during the biggest inflationary shock of the 1970s, they managed to sell less than a quarter of their portfolio. With core inflation now down to just 1.1% and a medium-term forecast in the same range, a full recovery would likely push the economy back into outright deflation.

If termination is unappealing, what are the other options?

First, the central bank could transfer reserves to Swiss citizens. After all, the SNB only recycled national current account surpluses into claims on foreigners – something the Swiss people happily did until the global financial crisis. Transferring them into 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 portfolio of foreign exchange reserves has had an average return of only 0.4% per year. Professionalized management could help generate higher profits with which to finance 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 real free float. In 2020, the US Treasury – rightly – labeled Switzerland a currency manipulator, putting diplomatic pressure on the NBS to back off. But Maxime Botteron, an economist at UBS, tells me the implications for Switzerland have been limited and have not prevented the SNB from buying new in 2021.

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