Comment: Swiss franc signals turbulence for euro
But the surge in its currency is a warning flash of lightning ahead of a storm building above European markets. The Swiss National Bank, faced with a wall of money cascading into the country – could that ever be a problem for Scotland? – broke its previous commitments, scrapped its exchange rate peg and slashed its key interest rate to an unprecedented minus 0.75 per cent to staunch the inflow.
Such is the tsunami of funds flowing from Russia and across Europe – even from Italy and Greece – that the national bank was no longer able to cope.
“Drastic”, “panic” and “total capitulation” were among the more moderate criticisms directed at the national bank. The country’s exporters are appalled.
So what has triggered this flood into Switzerland? Two events this week are responsible. The first, on Thursday, is a meeting of the governing council of the European Central Bank. There is now a broad consensus that it will announce – at last – a programme of quantitative easing (QE): pumping newly created money directly into the economy by buying assets (usually government bonds) from banks and insurers. This works to boost the supply of money for lending to businesses and households. This, combined with ultra-low interest rates, will work to weaken the euro. Hence the stampede out of euro currency assets into Switzerland, and the strengthening of sterling to a seven-year high against the euro; headache piled upon headache for UK companies seeking business in what is our biggest export market.
Last week, European Central Bank executive board member Benoît Coeuré said that discussions were now “far advanced” and had progressed into technical detail. “We are ready to take a decision on 22 January. That doesn’t necessarily have to mean that we will actually decide.” But the falling oil price, he added, “strengthens the risk in the current environment that people lose trust in our inflation goal”.
Italy’s central bank governor Ignazio Visco has also warned that “if the inflation figures remain very low for too long and the economy hardly grows, we risk being drawn into a downward spiral that will intensify itself on and on – that’s what we call deflation… In this situation, the most effective means is buying sovereign bonds.”
Now the euro area headline annual inflation rate has already fallen to minus 0.2 per cent, the first negative reading for five years. With continuing falls in the oil price, it may fall to minus 0.4 per cent this month, with a longer period of negative inflation likely during 2015.
Analysts, faced with a sluggish Eurozone economic performance, have been screaming at the ECB to launch QE for two years. So why has it taken so long?
The German Bundesbank has long been opposed to ECB buying of government bonds and the pooling of Eurozone debt, fearing that this would let heavily indebted Eurozone members such as Italy and Greece off the hook of painful structural reform. “Cheap money” on this view should not weaken the pressure to reform.
German opposition to QE reflects a red line its government has maintained throughout the euro crisis. And these concerns are widely shared by German voters – an opposition well understood by chancellor Angela Merkel. Any ECB decision to proceed with QE would entail loss of face for the German government.
Others have disputed the need for further monetary easing and argued that the threat of deflation is largely nonexistent. They point to the future benefits of cheaper oil on economic activity and worry about German taxpayer money being used to buy Greek bonds. Better, they argue, that QE is confined to corporate debt purchase, thus removing concerns over the monetary financing of unreliable governments.
The concerns over Greece are set to be heightened by elections taking place in the country next Sunday.
Ahead of this, the chief problem for ECB president Mario Draghi is how to prevent worsening deflation while working out how a government bond-buying programme could avoid the charge of backing delinquent policy. The likelihood is of a compromise deal, falling short of the ¤1 trillion package widely urged and opting instead for a more modest ¤600 billion programme to carry doubters within the ECB. Under this, a share of the QE programme would be mutualised through the ECB – between 20 and 30 per cent of the total – and that the remainder would remain on national central banks’ balance sheets.
But the problem with this is that it might lack the “bazooka” impact that would convince markets of the ECB’s determination. Without this it may fail to gain the credibility it seeks in its anti-deflation policy. Additional QE action would be necessary.
Opinion polls in Greece suggest the radical left-wing Syriza is on course to win a mandate for anti-austerity policies that many would deem inconsistent with continued euro membership. Just 36 per cent of the final vote is the approximate threshold beyond which a strong anti-austerity government is plausible. Syriza’s performance has been consistent with this in each of the past 20 opinion polls, with over 40 per cent of the vote on average in the past five.
Previous experience in mid-2012 suggests voters, confronted with the abyss before them, could swing at the last minute towards the more centrist New Democracy. But Syriza could achieve a decisive majority by squeezing out smaller parties as voters herd to the big two. And a decisive Syriza victory would make it unlikely that Greece would adopt the full austerity programme.
In this event, Greece would be back on the precipice. Little wonder that, ahead of this, Greek financial markets have fallen, bond prices have sagged to reflect default probabilities and there has been a flight of footloose capital into the Swiss franc. These lightning flashes signal a turbulent week ahead for the euro – and it is unlikely business and investor confidence in the UK will remain immune.
SUBSCRIBE TO THE SCOTSMAN’S BUSINESS BRIEFING