The Swiss central bank cut its interest rate close to zero today and started buying foreign currencies to stem the franc’s appreciation in the face of a deepening recession and a looming deflation threat (Hat Tip`MacroMan). The result was pretty predictable, the franc plunged the most against the euro since the single currency was introduced, dropping as much as 3.2 percent after the announcement, and hitting 1.5304 per euro at one point. Heady days ahead folks, fasten up your safety belts for what is now bound to be a bumpy ride. Central banking has never been so interesting.

With Switzerland’s economy set to shrink between 2.5 percent and 3 percent this year, according to SNB forecasts, and prices about to decline by at least 0.5 percent this year (with inflation “very close to zero” in 2010 and 2011) the bank is obviously very worried about following Japan into the deflation hole, and is determined to at least go down fighting. Dropping your currency violently is one of the best know remedies to fight deflation (see Lars Svensson – various, and now Deputy Governor of the Riksbank – if you have any doubt), that and pumping liquidity hard and fast into the system. But what if the UK, the US, the Eurozone and Japan all want to “ward off deflation” in the same way? Won’t we be back to the 1930s. Exactly. So someone has to play the part of the “big man” here, and take deflation firmly on the cheek. I don’t exactly see the candidates lining themselves up right now, although China is stepping up to the plate at the moment (more out of fear of what would happen if they devalue I think, than out of conviction it is a good policy for them). Will the eurozone be next? Watch Jean Claude Trichet’s after-the-rate-meeting April comments for the next episode in this thrilling story.

The economic situation has deteriorated sharply since last December, and there is a risk of negative inflation over the next three years. Decisive action is thus called for, to forcefully relax monetary conditions. Against this background, the Swiss National Bank (SNB) is making another interest rate cut and acting to prevent any further appreciation of the Swiss franc against the euro. To this end, it will increase liquidity substantially by engaging in additional repo operations, buying Swiss franc bonds issued by private sector borrowers and purchasing foreign currency on the foreign exchange markets. The SNB is lowering the target range for the three-month Libor by 25 basis points, narrowing it to 0–0.75%, with immediate effect. It will use all means at its disposal to gradually bring the Libor down to the lower end of the new target range, i.e. to approximately 0.25%. Thus, the Libor now has a narrower target range of 75 basis points, compared with 100 previously.
SNB Statement

Update Friday

It seems over at the Financial Times they broadly agree with the above interpretation, since in an article in today’s edition headed “Swiss action sparks talk of ‘currency war’” by Peter Garnham you can find the following:

Analysts said the move was likely to increase talk that countries were set to engage in a bout of competitive devaluation.

“Let the currency wars begin,” said Chris Turner at ING Financial Markets.

Countries around the world faced with the constraint of zero interest rate levels might feel it was acceptable to intervene to weaken their currencies in order to ease monetary conditions, he said, adding that other export-dependent economies such as Japan would “probably be at the head of the queue”.

Michael Woolfolk at Bank of New York Mellon agreed.

“Market intervention by a major central bank such as the SNB opens up the door for other central banks, namely the Bank of Japan, to follow suit,” he said. “The yen is widely perceived in Japan to be overvalued.”

The IMF, 3 days ago, to Switzerland —

Under the current circumstances, direct foreign exchange intervention should be aimed only at countering disruptive short-term pressures on the currency.

This followed an acknowledgment that monetary policy measures were probably headed towards zero interest rate and quantitative easing type measures.  So what did the Swiss National Bank do today?  The expected monetary policy easing, plus a blatant direct foreign exchange intervention —

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Well sometimes it never rains but it pours, and as far as Germany is concerned, economically speaking (and my condolences to each and every German for yesterday’s tragedy) more than a “rainy season” what we seem to have is a monsoon, with a torrential downpour one day after the next. The lastest piece of bad news comes on the export front, with German exports dropping for a fourth consecutive month in January, as what is still Europe’s largest economy fell ever deeper into what is now its worst recession in 60 years. Working day and seasonally adjusted sales abroad fell 4.4 percent from December (when they dropped 4 percent). According to provisional data from the Federal Statistical Office, Germany exported goods to the value of EUR 66.6 billion and imported commodities to the value of EUR 58.1 billion in January 2009. Exports were thus 20.7% down in January when compared with January 2008, and imports were 12.9% down.

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Ireland’s PM Brian Cowen today updated the Dail (lower house) on the still deteriorating state of the economy.  One thing his remarks unintentionally highlighted is the problems that governments create for themselves when they are sitting on their internal economic projections which they treat as confidential but then still demand that everyone needs to contribute to the “debate” over how to mitigate the crisis.  Anyway, the Opposition did coax him into revealing the GDP growth decline forecast for 2009 and he helpfully revealed the rate of downward revision —

It was said at budget time [October] it would be in the region of 2%, it was said in January it would be approximately 4% and the indications are now that it could be 6% or 6.5%.

So the revision is about minus 1 percentage point per month, which is probably on a par with former Baltic Tiger levels.   And senior policymakers still hint that the domestic banking system is a very fragile state.  So those green shoots of recovery, ends of tunnels or whatever are not being sighted in Ireland yet.

Incidentally, Cowen also recently cited Canada as his preferred model for financial sector regulation.   Various things contribute to Canada’s relatively less severe manifestation of the crisis.  The IMF helpfully points to one of them —

Complementing monetary policy, the floating exchange rate policy has also served Canada well, serving as a shock absorber. The recent depreciation of the exchange rate, which has occurred in line with the decline in commodities prices, will dampen disinflationary pressures and support activity.

Not an option that Ireland has.

The macroeconomic data coming out of Estonia in recent weeks are truly shocking even in the context of the ten percent annual drop in GDP for 2009 that most observers are now forecasting. Perhaps the most evocative number of all is not the 27% year on year drop in industrial output registered in January, but the announcement this week that Estonia’s registered unemployment rate rose to a record 7.4 percent during the first week in March, with a total of 47,774 job-seekers registering with the unemployment offices, up 3,019 in a week. Of course, for many outsiders these are not large numbers, but then Estonia is not a large country. Still this was the highest number since the Labor Market Board started disemminating data in 1993 (although not as measured by Eurostat, which uses a different methodology). The level was up from 7.1 percent at the end of February and 6 percent in January, although the important thing is not the volume of unemployment, but the rate of its increase.

At the same time it is estimated that nearly 250,000 Estonians are currently living in homes whose market value is insufficient to cover the outstanding mortgage loans which their owners have taken out, making “exposure risk” a growing problem for the country’s banks. During the boom, house sale transactions were commonly financed with a 90% loan to value (LtV) ratio. This is a very dubious practice at the best of time, but in the face of a sharp fall in both house values and wages it becomes well nigh disastrous. Continue reading →