Swiss franc dives as SNB sets target rate

LONDON: The Swiss franc plummeted versus the euro and dollar on Tuesday after the Swiss National Bank set a minimum exchange rate target of 1.20 francs per euro to combat the strength of the Swiss franc which it says poses a risk to the economy.

The single currency leapt to the target almost immediately on trading platform EBS from levels of 1.1270 before the announcement. It was last up further at 1.2150 francs, up around 9 percent on the day.

The dollar also jumped to 0.8370 francs versus around 0.8000, while the euro rose sharply to $1.4286 , up more than 1 percent on the day after trading almost flat beforehand.

"Our model suggests a minimum rate of 1.25 in euro/Swiss is needed to ward off a deflationary threat, which suggests we could see a move to 1.25-1.30 over the next month, maybe sooner," said Gavin Friend, currency strategist at National Australia Bank.

The SNB said it would enforce the minimum target exchange rate by buying foreign currency in unlimited quantities and some analysts said the move would make it cheaper for investors seeking to get out of euros to reduce exposure to the euro zone debt crisis, even if it now was more costly to hold francs.

The SNB said it would no longer tolerate a euro/Swiss franc exchange rate below 1.2000 and would do everything within its means to defend that level.

To cushion the economy from a downturn as the strong franc hurts exports, the SNB cut its already low interest rate target to nil on Aug. 3. It is also boosting the amount of liquidity in the banking system, effectively driving banking interest rates into negative territory, and had threatened further measures.

EURO RISK AHEAD

Before the SNB statement shocked investors, the euro had been under pressure as Italian government bond yields looked set to head back to levels above six percent on worries over Rome's ability to agree a new austerity package.

German Chancellor Angela Merkel added to investor nerves over Italy late on Monday, telling members of her Christian Democratic Union party that the situation in the euro zone's third largest economy was "extremely fragile".

Market players said the key risk for the euro this week is that the European Central Bank is likely to signal that it will take a pause in its rate tightening cycle.

"Without the support of a more hawkish central bank, the euro will look very vulnerable," Societe Generale strategists Kit Juckes and Sebastien Galy wrote in a note, adding a fall below $1.3900 could take the common currency back to $1.3000.

The finance ministers of Germany, the Netherlands and Finland will meet to discuss the controversial topic of collateral for loans to Greece on Tuesday, and Germany's constitutional court will rule on Wednesday on the legality of euro zone bailouts.

Meanwhile, analysts worry that Greece's ongoing dispute with the EU and IMF on fiscal slippages could delay its next tranche of aid and worries about European bank funding are also adding to risk surrounding the euro.

The dollar index earlier climbed to a one month high at 75.305, before easing to last trade flat at 75.101, while the greenback rose 0.2 percent versus the yen to 77.08.

Copyright Reuters, 2011