Are you sure?

Swiss rate rise turns screw on East Europe

Switzerland has raised interest rates a quarter point to 2.5% with warnings of more to come, squeezing speculators who have borrowed heavily in Swiss francs to play Europe's 'carry trade'. The move will have ripple effects far beyond Switzerland, driving up mortgages across much of Eastern Europe. 

In Hungary, over 80% of all new home loans and half of small business credits have been taken out in Swiss francs over the past year. A similar pattern is emerging in Croatia, Romania, Poland, and the Baltic States, although the mix between francs, euros, and the yen varies. The fashion for borrowing in Swiss francs began this decade when Switzerland dropped rates to 0.75% to stave off deflation, making it the cheapest source of capital in Europe. External lending in Swiss francs has reached $643 billion, says the Bank for International Settlements . The huge scale of borrowing has driven the franc to a nine-year low against the euro, with an accelerating slide over the last two years - even though the Swiss National Bank has raised rates seven times in the meantime. The extreme weakness is perverse, since Switzerland enjoys the highest current account surplus in the developed world at 17.7% of GDP. The Swiss hold more than $500 billion in net foreign assets, making them the wealthiest nation on earth.

Jean-Pierre Roth, the SNB's president, said the currency's slide was disrupting the Swiss economy, now growing at 2.5% a year. „The weak franc could heighten inflationary pressure in an economy already running at full steam. We see a need for further interest rate increases if things do not calm down,” he said. Although Swiss inflation is just 0.8%, there are signs of incipient overheating in many sectors. Unemployment fell to 2.8% in May. Roth said a 40% rise in oil prices since January would fuel inflation later in the year. Moec Gilles, an economist at Bank of America, said the SNB was starting to bare its fangs. „International investors have been given a clear warning: if they continue using the Swiss franc for the Europe-wide carry trade, they may face a significantly higher refinancing cost when the franc rebounds,” he said. Jens Nordvig, FX strategist at Goldman Sachs, said the global carry trade was nearing exhaustion. „It has performed very well for two years in a climate of low and declining volatility, but volatility is starting to rise. I'm not saying the sky is going to fall, but 'carry' is becoming less attractive.” Nordvig said Swiss rates had lagged rises in other countries, but this may soon change. „The franc is now so low so that we could see the SNB hike rates beyond the point when the European Central Bank stops.”

The markets nevertheless shrugged off Roth's hawkish comments, relieved that the SNB had not raised rates 0.5% in a shock move to scorch speculators. The franc continued to lose ground yesterday against the euro, slipping to €1.6584. David Bloom, a currency expert at HSBC, said it would take a lot more than a quarter point rise to stop the lucrative game. „The Swiss franc is a safe-haven currency but right now investors want sex and violence. They want to be part of the big exciting boom out there, at least until something calamitous happens and then we'll find out how big this whole carry trade is,” he said. „In the Cold War, the Swiss franc was the ultimate safe-haven currency but we're in a new world now. You could argue that the franc is a relic and that it should weaken to reflect an aging population. But then people said that before 9/11, and what happened? Everybody wanted Swiss francs again,” he said. (