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Switzerland is fighting back against investors who have driven its currency to unbearable new heights amid global uncertainty that grows by the day.

No sooner had Washington settled its fight over the government's debt ceiling than the focus shifted quickly back to the 17-member euro zone, where troubles have raged for more than a year. And now, Europe's leaders are fighting on several fronts as their fiscal crisis threatens to engulf some of the region's bigger economies.

Switzerland's central bank moved aggressively Wednesday to halt the surge in the franc, whose rapid appreciation reflects the continuing euro zone turmoil.

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Fearful global investors are reacting to the extreme uncertainty by flocking to such traditional safe havens as gold, Swiss francs and U.S. Treasuries. Other safe-haven currencies, including the Japanese yen, as well as the Canadian and Australian dollars, and, lately, the Brazilian real, have also been boosted by the flight from risk.

But when it comes to safe islands in a sea of worry, few can match the Swiss currency's appeal. And there is little the central bank can do to reverse the tide. What's worse, it can end up severely damaging its own balance sheet.

"I would equate it to gold," said Andrew Busch, global currency and public policy strategist with BMO Nesbitt Burns Inc. in Chicago. "When investors really have no conviction that we're either going to get growth or they're really comfortable with extremely low interest rates in countries like the United States, this is where they end up going."

The Swiss National Bank lost $13.48-billion (U.S.) on its currency positions in the first half of this year, stemming from interventionist measures taken in 2010.

The latest Swiss intervention came amid more alarm bells in Europe set off by an emergency meeting of Italian Finance Minister Giulio Tremonti and Jean-Claude Juncker, chairman of the group of 17 euro zone finance ministers who have been grappling with the region's burgeoning debt crisis.

Mr. Tremonti and his boss, Prime Minister Silvio Berlusconi, have repeatedly insisted debt-laden Italy is on solid financial footing, even as the government embarks on an unpopular austerity program designed to shore up the country's battered finances and restore the bond market's shaken confidence. The problem is that the market has heard such brave talk before, from the political leaders of Greece, Ireland and Portugal, just before all three small euro zone members were forced to seek bailouts to avert defaults.

Now vastly larger Italy and Spain are facing punishing interest rates in excess of 6 per cent on 10-year benchmark bonds, dramatically increasing the costs of financing their debt at a time when their economies are losing ground.

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Italian and Spanish benchmark bonds strengthened slightly Wednesday after hitting record yields earlier in the day. Italy's 10-year debt yielded 6.227 per cent at one point and Spanish yields reached a high of 6.388 per cent. Rates of 7 per cent or higher are regarded as the breaking point that could force both countries to abandon public financings.

The SNB, worried about the impact of the strong currency on the country's vital export sector, effectively cut already low interest rates to zero in an unexpected move and revealed plans to "very significantly" boost the supply of currency in the money market.

The franc promptly weakened in response, but is bound to resume its upward trajectory, analysts warned, because such interventions rarely succeed in reversing a strong market trend. Indeed, after initially falling against most of its main counterparts, the Swiss currency soon recovered and remained near record highs against both the euro and the U.S. dollar.

"The SNB would be well advised not to intervene," Mr. Busch said. "The lowering of interest rates will help, but most people look at Switzerland as Germany without the euro." In other words, Switzerland is regarded as an attractive country with an expanding economy and a relatively sound fiscal position that stands out in sharp contrast to the troubled euro zone.

However, that will not stop the central bank, which fears the strong Swiss franc will derail the export-dependent economy.

Few doubt the Swiss franc is overvalued based on economic fundamentals, and that this has begun causing grief for the country's crucial manufacturing exporters. Shipments are slowing and corporate profits are shrinking, in the face of an increase in the value of the franc this year of more than 10 per cent against the euro and 16 per cent against the U.S. dollar.

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The latest sounding of Swiss purchasing managers released Tuesday showed little change in the manufacturing index, which was at 53.5 in July, compared with 53.4 the previous month. But the index remains below its peak a year ago. And a rise in inventory levels signals that the strong franc is starting to bite into sales.

The bank issued a strongly worded statement, calling the "massively overvalued" Swiss franc a threat to the economy and to price stability and warning that it is prepared to take other steps to stop the economy-damaging spike in the currency. The bank declared that it "will not tolerate a continual tightening of monetary conditions."

The SNB's "determination should not be underestimated," said Beat Siegenthaler, senior foreign-exchange strategist with UBS in Zurich. "Their statement was a very aggressive one and they will follow with further action if the franc continues to strengthen."

The central bank move "will help put a marker down and create a new range [for the currency]," said Alain Bokobza, head of global asset allocation with Société Générale in Paris. "But unless the global search for safe havens ends, the Swiss franc's status as last and best safe haven of all will remain."

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More

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