Currency cap: The doves will be smiling in Frankfurt

On the face of it, the collapse of the euro against the Swissie yesterday looks like an embarrasing vote of no confidence in the European Central Bank. It suggests investors are rushing for the single-currency exit door and piling into the protective arms of the Swiss safe haven.

The fact the Swiss National Bank (SNB) abandoned the three-year cap on the franc strongly suggests the central bankers of Zurich expect more of these safe haven flows to come next week when the ECB launches its own quantitative easing programme.

“This is a massive message from the SNB to the market: ECB is going to QE and it’s going to be big,” as analysts at Goldman Sachs put it yesterday.

But the reality is that Mario Draghi and the other doves in Frankfurt will not be overly worried by yesterday’s currency market mayhem. This can be explained by considering the channels by which QE is expected to work.

There will be no real economic benefit from pushing sovereign bond yields in the eurozone lower. They are mostly already at rock bottom. The main potential economic gain from soveriegn bond purchases lies in the impact on other asset prices and market expectations.

Some hot money will flow out of German bunds and head abroad to places like Switzerland. But much will also likely flow into riskier eurozone assets like equities.

The fall in the value of the euro will also be viewed as helpful by many in Frankfurt, both for increasing the international competitiveness of eurozone exports and also for pushing up import prices.

That is precisely the medicine required to prevent the infection of deflation from spreading further through the eurozone’s body.