Inflation in Switzerland is running around 4% lower than its main trading partner, the eurozone

EUR/USD tumbled to 20-year lows. But while euro/dollar might have stolen all the headlines, it may be the 7-year low in EUR/CHF that is actually of more significance.

There are a couple of reasons. The first is that the Swiss National Bank (SNB) has turned from a bank that’s worried about deflation into one that’s concerned about inflation. Of course, that’s pretty universal, with the exception of the Bank of Japan at the moment.

But the difference with the SNB, which is the second factor, is that it has very actively used currency intervention in the past to achieve its inflation aims. While most other developed-country central banks around the world bought bonds to expand liquidity and lift inflation, the SNB has bought foreign currencies instead. But now that inflation is the problem, rather than deflation, the SNB appears to have stepped back from intervention just as many bond-buying central banks elsewhere have stopped quantitative easing. Ending quantitative easing has led to higher bond yields and a cessation of SNB currency intervention – if that’s the case – seems likely to lift the franc against the euro.

The fact that this action has been bolstered by the first SNB rate hike in June, ahead of the ECB, should also serve to boost the franc against the euro. The franc has already reached its best levels against the euro since early 2015 by moving through the parity level and looks set to plunder more gains in the future.

But what does all this have to do with euro/dollar, given that the SNB’s focus has been euro/Swiss, not euro/dollar? Mr. Steve Barrow, Head of Standard Bank G10 Strategy mentioned many times in the past that movements in Euro/Swiss and associated intervention by the SNB can have a bearing on EUR/USD. On one side of the equation, these EUR/CHF purchases by the SNB can serve to support the EUR elsewhere, such as against the dollar. This being said, there’s also an impact on the other side of the equation because the SNB rebalances reserves by selling some of the EUR for USD.

At the end of March, the SNB had some 39% of reserves in dollars and 37% in euros. It seeks to maintain these sorts of proportions and hence, if its franc-selling intervention is primarily conducted against the euro, it will sell close to 40% of these euros for dollars; something that, all things equal, will put downward pressure on euro/dollar. So, rather than arguing that SNB intervention might be leading to a significant directional move in EUR/USD, either up or down, it might be more appropriate to suggest that these currency flows are supressing volatility by providing pressure for both a stronger and a weaker EUR/USD.

Now given that trading volumes in euro/dollar were put at over USD1.5tr per day at last count (2019), it might seem that SNB intervention is pretty inconsequential. But Swiss reserves have soared in the past as it has fought hard to weaken the franc and these intervention-related flows are not insignificant amounts for the market to absorb. If this period of rapid reserve accumulation and intervention is over, even temporarily, it seemingly gives the euro more freedom to move against the dollar. Quite clearly, this could mean the freedom to move up as well as down, but Mr. Steve Barrow suspects that the latter is far more likely at the current juncture. If euro bears were in any way reticent in the past to believe that EUR/USD could move down sharply – particularly if EUR/CHF was falling at the same time – then these concerns could have evaporated now that the SNB is out of the way.

Of course, if EUR/CHF slumps dramatically, towards 90 cents, or lower, the SNB could enter the FX market again in significant amounts, especially if Switzerland starts to turn the corner on rising inflation. But we are not there yet and may not be for some considerable time. If that’s a fair reflection of the situation it seems that EUR/USD might not just meet the parity target that we have had for many months now, but fall even further.