Bloomberg News

SNB Keeping Eye on Denmark to Stem Capital Flooding Switzerland

July 25, 2012

Swiss National Bank President Thomas Jordan

Swiss National Bank President Thomas Jordan said in an interview with Handelsblatt published on July 3 that the central bank doesn’t exclude any measure to weaken the franc. Photographer: Valentin Flauraud/Bloomberg

Swiss National Bank (SNBN) President Thomas Jordan has good reason to keep his eyes on Denmark as Switzerland looks at tougher tools to weaken the franc.

With both nations seen as havens, central bankers in Zurich and Copenhagen are struggling to keep their currencies from appreciating. While the SNB was forced to step up euro purchases to keep a lid on the franc, Denmark’s Nationalbanken on July 5 took the fight against investors to a new level by cutting the interest rate it offers on certificates of deposits below zero.

“You can safely assume that the Swiss central bank is closely watching what their Danish colleagues are doing,” said Maxime Botteron, an economist at Credit Suisse Group AG (CSGN) in Zurich. “Should the situation deteriorate, they might follow suit and introduce negative rates on banks’ sight deposits.”

SNB Vice President Jean-Pierre Danthine, who has worked with government officials to assess additional tools, said last month imposing negative interest rates “is a measure we could consider if the circumstances warrant it.” Jordan said in an interview with Handelsblatt published on July 3 that the central bank doesn’t exclude any measure to weaken the franc.

Record Deposits

As the euro area’s fiscal crisis worsened, sight deposits in both countries were pushed higher with central banks stepping up euro purchases and crediting lenders’ deposits with the amount of their respective currencies sold.

While the Nationalbanken’s certificates of deposit declined from a record after the rate cut, the SNB’s average sight deposits reached a fresh all-time high of 261.4 billion francs ($263 billion) in the week of July 20. SNB foreign-currency reserves surged to 364.9 billion francs at the end of June from 305.9 billion francs in the previous month.

Lowering the interest rate, which the central bank pays to commercial lenders on their deposits, creates an incentive for the banks to invest in other assets. That’s easing pressure on the franc or the krone. Negative rates create an even stronger fillip to reduce sight deposits as banks have to pay a fee for holding them instead of receiving a remuneration.

While Swiss banks currently don’t pay interest on the deposits they hold with the central bank, lenders earned 0.05 percent on their certificates of deposit in Denmark before the central bank decided to cut the rate to minus 0.2 percent.

Overvalued Currencies

Denmark has an agreement with the European Central Bank to let the krone swing no more than 2.25 percent from a rate of 7.46038, though it maintains a tighter band in practice. The Copenhagen-based central bank, led by Nils Bernstein, doesn’t hold scheduled meetings and only adjusts rates to defend the krone’s peg to the euro. Nationalbanken’s decision came the same day the ECB cut its benchmark rate to a record low.

In Switzerland, the SNB imposed a franc ceiling of 1.20 versus the euro in September, a measure last used in the 1970s, to fight deflation threats after the currency surged as much as 37 percent in the previous twelve months.

The Swiss currency remains 36 percent overvalued against the euro, based on purchasing power parity as calculated by the Organization for Economic Cooperation and Development. That compares with 24 percent for Denmark’s krone.

Kasper Kirkegaard, a senior currency analyst at Danske Bank (DANSKE) in Copenhagen, said given the increase in the SNB’s currency reserves to defend the cap, “it would be natural” for them to consider taking additional measures at some point.

‘Test Case’

“Other countries see Denmark as a test case to see how the economy and banking system react to negative interest rates,” he said. “The Danish krone has weakened marginally and that has taken some pressure off the Danish central bank. Of course, if the European crisis escalated further, it would take quite a lot to prevent investors from buying the krone or franc.”

Still, some economists argue that Swiss policy makers have less of an incentive to introduce negative interest rates than their Danish colleagues. Ulrike Rondorf, an economist at Commerzbank AG in Frankfurt, said such a move would have “serious, unintended side effects” in Switzerland.

“By imposing negative rates, central banks hope that commercial banks funnel the money into the market for loans,” said Karsten Linowsky, a fixed-income strategist at Credit Suisse in Zurich. “In Switzerland, the credit market is functioning very well. From that point of view, there’s no reason for the SNB to introduce negative rates.”

Property Bubble

Denmark’s banks are struggling to emerge from a burst real estate bubble that has sent house prices plunging 25 percent since their 2007 peak. Two thirds of the country’s regional lenders reported losses last year, leaving the industry reluctant to withdraw funds from central bank accounts.

Lending by banks and mortgage providers rose less than 2 percent in each of the first six months of 2012 compared with a year earlier, Nationalbanken said on July 24. In Switzerland, lending increased an annual 4.1 percent in the first quarter and the SNB has said there is no sign of a credit squeeze.

Swiss officials have said they are weighing stronger measures just in case the euro area’s turmoil escalates. A government-led panel in cooperation with the SNB is “regularly assessing the implementation of additional, complementary measures to fight the franc’s strength, measures that are not the sole competences of the SNB,” such as capital controls, Finance Minister Eveline Widmer-Schlumpf said on June 15.

Those steps “would only be taken as the very last resort,” she told parliament, a day after the SNB kept its franc ceiling at 1.20 and the benchmark interest rate at zero.

‘Support Measure’

Serge Steiner, a spokesman at UBS AG (UBSN), said that the introduction of negative rates would be “technically feasible” for Switzerland’s largest bank based in Zurich. Bernard Droux, a managing partner at Lombard Odier & Cie., Geneva’s oldest bank, said such a move would be “very difficult” and “counter- productive” for the industry.

Credit Suisse said in a note on July 23 that negative interest rates would “likely act as a support measure” to the SNB’s currency policy and could “persist for several months up to several years, depending on the context.”

“The SNB is certainly following what the Danish central bank is doing,” said Alexander Koch, an economist at UniCredit Group in Munich. “However, further unconventional measures like negative interest rates or capital controls will likely only be adopted in the case of a worst-case scenario regarding the euro- area debt crisis, putting enormous pressure on the franc.”

To contact the reporters on this story: Klaus Wille in Zurich at kwille@bloomberg.net; Frances Schwartzkopff in Copenhagen at fschwartzko1@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net


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