MercoPress. South Atlantic News Agency

Swiss central bank puts a cap to the Franc to combat massive overvaluation

The Swiss central bank will buy all Euros if the exchange rate drops below 1.20 Euros

The Swiss central bank announced Tuesday a ceiling on the currency by setting an exchange rate minimum against the Euro. The Swiss National Bank (SNB) boldest move states that the exchange rate between the Swiss franc and the Euro must not drop below 1.20 Euros. And if it does, the Swiss bank is prepared to enforce the minimum by selling francs and buying up euros “in unlimited quantities.”

“The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development,” said the SNB in a statement.

Immediately following the announcement, the Swiss franc sank 8.5% to trade right around 1.20 Euros.

“This is the most aggressive step the Swiss have taken in the history of the SNB to combat the Swiss franc’s rise” said Kathy Lien, director of currency research at Global Forex Trading. “They're hoping this will diminish speculative interest and safe haven attraction to the currency”.

Nervous investors have sought safety in the traditional safe haven asset. Since the start of the year, the Swiss franc has surged nearly 20% against the Euro due to growing global economic uncertainty. Just last month, the franc strengthened enough to trade close to parity against the Euro.

A strong franc makes Swiss goods less attractive to trading partners, and tourists, a major source of income for Switzerland, are less likely to visit. The Swiss central bank has tried to step in to cool the rally by cutting interest rates, but to no avail.

Lien said the latest move should help stabilize the currency, but it could be an uphill battle.

“The reason the Swiss franc has been climbing so fast recently is because of the sovereign debt crisis in Europe” she said. “Europe is still very much in trouble, and if problems keep flaring up, investors will still be tempted to park their money in the Swiss franc”.

That could make this commitment to stem the franc's value costly for the Swiss banks, which has about 150 billion Euros in reserves to spend on intervention, Lien said.

The SNB took similar measures in March of 2009, when the Swiss franc rose as high as 1.45 Euros, and the central bank spent 4 billion Euros to stabilize the franc above 1.50 Euros, said Lie.