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The cheapest franc in three years. Will it continue to fall?

4 Jan 2018 11:23|Marcin Lipka

"The very beginning of January brought a deepening of franc depreciations. The Swiss currency is 1 percent lower than at the end of December and almost 15 percent lower than it was at the beginning of last year. What had an impact on those significant changes and can we expect further decreases?" asks Marcin Lipka, Conotoxia Senior Analyst.

Marcin Lipka, główny analityk Cinkciarz.pl

Positive economic sentiment in the eurozone, combined with the Swiss National Bank's actions and a relatively strong Polish currency, have caused the franc valuation, in relation to the zloty, to fall to its lowest levels since the beginning of 2015.

A year ago, one franc cost 4.10 PLN, which is almost 0.50 PLN more than now. Today, the exchange rate finally returned to the pre-release level of the peg by the Swiss National Bank (SNB).

Firstly: signs from the eurozone

The main reason for the strong franc over the last few years was the weak condition of some euro area countries. The debt crisis caused investors to begin valuing the risk of collapse of the single currency area, and the franc was supposed to be a protective tool before its negative consequences.

Moreover, the economic issues have translated into increased political risks, which were clearly seen at the beginning of last year. Only the victory in the French elections of Emmanuel Macron significantly reduced investor fears about the stability of the eurozone. Since then, the euro in relation to the franc has grown by 10%.

Reducing systemic risks for the eurozone has improved sentiment among European businesses and consumers. This has caused faster than expected economic growth and the start of withdrawal from a very soft monetary policy by the European Central Bank.

Secondly: Swiss action

The SNB monetary policy has been a significant element, reducing the appetite for Swiss assets during the crisis and contributing to the franc's weakening in the past months. The Swiss monetary authorities maintained negative interest rates and suggested an intervention to weaken the franc. Despite recent declines, SNB has continued to state that the Swiss currency is "highly priced".

Currency interventions are clearly proved in the data published by SNB. The assets of the central bank expressed in foreign currency over three years (data for Q3 2017) have grown by over 300 billion francs - to 784 billion francs (almost 120% of GDP).

By buying foreign assets, the central bank sells francs and, therefore, weakens the local currency. According to SNB's data for Q3, 80% of assets are foreign bonds (mainly highly rated treasury bonds). The rest is mainly stocks. At the end of 2016, the Swiss central bank possessed shares of about 6,5k companies worldwide. On the other hand, data from the US Securities and Exchange Commission (SEC) show that in the US alone, SNB's wallet includes shares in 2755 companies worth more than 100 billion USD (three years ago it was 25 billion USD).

The SNB messages have not indicated that the policy of recent years has to be modified. Moreover, the macroeconomic projections also do not suggest that inflation should exceed the target by 2020, therefore, a change in monetary government action in the coming quarters should not be expected.

Is it time to stabilise?

The significant improvement of the economic perspective in Europe and other developed countries supports the emerging countries currencies valuation. The zloty, whose value in relation to the euro has increased by 5% over the last year, also benefits from this.

Many things indicate that the franc may still be weak, however, repetition of the 0.5 PLN drop which happened last year is unlikely. The global revaluation of the franc has been strongly revised in recent months. The zloty returned to long-term averages in relation to the euro. This limits the potential for beneficial changes for those who are repaying loans.

In addition, there is still a visible threat to today's very good global sentiment. Elections are scheduled in Italy for March. The result is uncertain and the risk of not forming a government is significant. Re-election in the autumn could increase the chance of the Eurosceptic groups winning, which, taking into account Italy's weak economic situation, is likely to contribute to the return of concerns on the single currency area's stability and may strengthen the franc. As a result, the annual average franc exchange rate close to current levels seems to be more likely than the continuation of significant declines.

4 Jan 2018 11:23|Marcin Lipka

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