Will the SNB’s decision impact what other central banks might do?

>> Central bank meetings and impacts on currency market

G10 central banks are like horses in the starting stalls at the beginning of a race to cut rates. It had been assumed that many of these central banks would come out at the same time – in June – and none would try to jump the start. But the Swiss National Bank destroyed this image with its surprise 25-bps rate cut. Does this move have anything to say about how other central banks may act in coming months, and does the slide in the Swiss franc risk causing a more general rise in G10 FX volatility?

The rate cut from the SNB was only a surprise in its timing. For given the crucial importance of the euro/Swiss exchange rate to the stance of Swiss monetary conditions, it was assumed that the Bank would likely cut at the same time as the ECB – in June – to avoid ructions in the exchange rate. However, it seems that ructions are exactly what the SNB wants. More specifically, weakness in the franc resulting from an ‘early’ rate cut could help to avoid inflation falling too far and the economy becoming too weak.

What we have to remember about the SNB is that its quantitative easing – and tightening – has essentially been done through the exchange rate and the accumulation and decumulation of FX reserves. This is because its bond market is too small to conduct the sort of bond buying operations that we have seen in other G10 nations.

In effect, central banks like the ECB and Fed have bought domestic assets; the SNB has bought foreign assets. Right now, the G10 central banks are scaling back those assets as part of a quantitative tightening. While that can impact domestic asset prices, specifically bonds, any SNB manipulation of the assets it holds does not impact local bond prices, but can impact the exchange rate and perhaps even the value of those foreign assets that it holds if its holdings are sufficiently large.

That’s not the case if we take something like treasuries, but there has been a lot of notice taken in the past of the SNB’s holdings of equities, particularly individual stocks. For other G10 central banks there’s more talk about slowing the pace of QT. The Fed, for instance, seems likely to announce plans at its next meeting to scale back its USD95bn balance sheet drawdown. This is being considered because G10 central banks are approaching the point at which policy rates will be cut and it seems wise to accompany this easing with less onerous QT.

For the SNB, this would seem to imply that the last two years of declines in FX reserves will come to an end. Indeed, most recent data shows reserves rising again. In theory, at least, the SNB could focus all of its monetary-easing efforts on resisting franc strength and accumulating reserves, but it has seemingly chosen not to do so. That might be because it views an ‘early’ rate cut as a better way to not just ease policy but also a better way to engineer weakness in the franc than intervention.

>> Should central banks ignore the Fed?

Does the SNB’s decision have a bearing on what other central banks might do? While no other central bank is going to pull forward rate cuts just because the SNB has jumped the start of the easing cycle, Mr. Steve Barrow, Head of the Standard Bank G10 Strategy said that central banks would do generally tend to think with one mind. So, what the SNB rate cut does is to provide more evidence, if any were needed, that central banks – and particularly the ECB – are minded to cut their own rates. In other words, it bolsters the idea that rates will be cut in June. Of course, this sentiment might serve to prevent the very Swiss franc weakness that the SNB is hoping to achieve by its ‘early’ rate cut.

“If the SNB cut had been totally out of the blue, and totally at odds with monetary policy elsewhere, the franc might have a better chance of extending this week’s slide. The corollary of this is that, although the SNB moved to cut rates earlier than expected, it will probably not do much to lift the rather moribund levels of volatility that we are seeing across G10 currencies right now. This even includes the Swiss franc where implied volatility levels are still around the lowest that we have seen in over two years”, said Mr. Steve Barrow.