The Swiss National Bank shocked global markets by scrapping its four-year old currency cap today. It pushed the Swiss Franc up as much as 37 per cent against the euro, while Swiss stocks shed as much as 10 per cent. Here's everything you need to know about the currency ceiling:
What was the so-called currency "ceiling"?
The currency "ceiling" was introduced back in 2011 at the height of the financial crisis.
Panicked investors seeking shelter from the tumultuous Eurozone crisis brought Swiss francs on the belief they would hold their value.
But the huge influx of capital hurt exporters, which was bad news for the Swiss economy. As more people brought the currency, the price at which Swiss exporters could sell their goods increased, which made them less competitive internationally and strangled demand.
This prompted the Swiss National Bank to take measures to stop the unfavorable increase. It started buying up euros in order to maintain a cap of 1.20 francs per euro.
Why did the Swiss Central Bank scrap it?
Apparently, the Swiss Central Bank decided the currency no longer needed defending, in light of a changing global economic environment:
While the Swiss Franc is still high, the overvaluation has decreased as a whole since the introduction of the minimum exchange rate. The economy was able to take advantage of this phase to adjust to the new situation.
Recently, divergences between the monetary policies of the major currency areas have increased significantly - a trend that is likely to become even more pronounced. The euro has depreciated considerably against the US dollar and this, in turn, has caused the Swiss franc to weaken against the US dollar.
In these circumstances, the Swiss National Bank concluded that enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified.
The prospect of full-blown quantitative easing from the European Central Bank - which would hammer the euro, sending even more investors into the Swiss franc - was also floated:
Why did the move take markets by surprise?
The Swiss central bank also further slashed interest rates to -0.75 per cent from -0.25 per cent. The plunge into negative rates was initially made in December as the bank sought to discourage investors from holding their cash in Swiss Francs. At the time it reiterated its commitment to the currency ceiling:
The Swiss National Bank reaffirms its commitment to the minimum exchange rate of SFr 1.20 per euro, and will continue to enforce it with the utmost determination. It remains the key instrument to avoid an undesirable tightening of monetary conditions resulting from a Swiss Franc appreciation.
Today's move was essentially a U-turn from the central bank's previous policy.