Swiss central bank seeks new tools in zero-interest world


By Joshua Gallu
Bloomberg News
Tuesday, December 2, 2008

ZURICH -- The Swiss National Bank is becoming the first central bank in Europe to learn what it's like to live in a zero interest-rate world.

"They simply don't have much room left on interest rates" following a 100 basis-point cut Nov. 20, said Reto Huenerwadel, senior economist at UBS AG in Zurich. "Still, they're actively using monetary policy and are looking for creative solutions" that may include buying bonds, intervening in currency markets, and expanding swaps with other central banks, he said.

With Switzerland following the rest of Europe into a recession, the central bank has slashed the short-term rate it uses to steer borrowing costs in the broader economy to 0.1 percent. As rates approach zero, SNB President Jean-Pierre Roth, like his counterparts at the U.S. Federal Reserve, may instead have to find new tools to restore the flow of credit through the economy and head off the risk of deflation.

Swiss policy makers have already injected billions of francs into the financial system, including a $59 billion package for UBS, and may next have to consider turning to "quantitative easing," says Fabian Heller, an economist at Credit Suisse in Zurich.

The unorthodox tool was last deployed by the Bank of Japan earlier this decade when policy makers kept their key rate at zero and flooded the banking system with cash to encourage lending.

... Liquidity

"The SNB has signaled it's ready to support the financial markets and help the economy recover," Heller said. "They'll certainly provide as much liquidity as needed."

The SNB will announce its next rate decision on Dec. 11, after which Roth will hold a press conference.

The SNB's challenge may soon be shared by other central banks in Europe. Bank of England Governor Mervyn King openly discussed the possibility of zero interest rates for the first time on Nov. 25. The European Central Bank will cut its benchmark rate to 1.5 percent next year, according to the median of 25 forecasts in a Bloomberg News survey, with Citigroup Inc. saying a move to zero is possible.

The Fed has already started to use more unorthodox methods. The U.S. central bank said on Nov. 25 it will purchase as much as $600 billion in debt issued or backed by government-chartered housing-finance companies. James Bullard, president of the Federal Reserve Bank of St. Louis, said on Nov. 21 that "more attention may have to be paid to quantitative measures."

... Fed Plans

Fed Chairman Ben S. Bernanke said yesterday he may use less conventional policies such as buying Treasury securities to bolster growth as the scope to lower the main U.S. rate from the current 1 percent is "obviously limited."

So far, the SNB has reached swap agreements with the ECB to get francs to banks outside Switzerland and helped bail out UBS, the nation's biggest bank, to tackle the crisis. Swiss policy makers have also had some success in pushing down their targeted rate, the three-month rate for borrowing in London.

The SNB has pulled the market rate down by 70 basis points to 1.24 percent since lowering the target to 1 percent on Nov. 20. The three-month rate fell 61 basis points the day after the announcement.

SNB President Roth argues that the central bank has room to lower its benchmark rate below 1 percent, saying the bank took the benchmark to 0.25 percent in 2003.

... Money Markets

Still, the SNB's success has come at a cost, with the one- week rate that it uses to steer its main rate now blunted. Complicating their task, money markets remain strained, indicating financial institutions are still hoarding cash after racking up almost $1 trillion in global losses.

With credit markets still partially frozen, Swiss policy makers may be better advised to boost the economy by steering the franc's exchange rate, said Alessandro Bee, an economist at Bank Sarasin. Exports amount to more than half of gross domestic economy and the currency has risen more than 8 percent against the euro this year.

"It makes more sense for the SNB to intervene in foreign- exchange markets than trying to influence long-term interest rates" by buying and selling bonds, said Zurich-based Bee. "Switzerland is a small, open economy. That makes less sense in the U.S. and Japan, which are much more closed."

... Indicators Decline

Swiss leading indicators dropped to the lowest in more than five years in November as the manufacturing industry contracted for a third month. Roth said Nov. 24 that the Swiss economy is probably already contracting and may shrink next year.

The International Monetary Fund predicts advanced economies will contract simultaneously in 2009 for the first time since World War II. In the euro region, Switzerland’s largest export market, manufacturing and service industries contracted at the fastest pace in at least a decade last month.

While the SNB will announce its rate decision next week, investors may nevertheless be more interested in Roth's proposals for reworking monetary policy to deal with the financial crisis.

The SNB has "used up its ammunition," Bee said. "The room to maneuver with traditional monetary policy has just gotten smaller."

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