What if the trickle into Swiss francs turns into a speculative flood?

Rupert Cornwell on a euro headache for Switzerland
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The Independent Online
IF BRITAIN'S monetary authorities are worried about sterling being pushed too high by doubts over a weak euro, imagine how the Swiss feel. Theirs is the ultimate safe haven currency, and eight months before the euro sees the light of day, rumours of speculative inflows abound. The German mark is brushing the 80 Swiss centime level which sets alarm bells ringing as loud in Berne as a 3-DM pound in London. If the Germans conclude the euro is not a patch on their currency-cum-national symbol, the trickle into Swiss francs could become a flood.

Of course, it's not that Switzerland isn't used to this sort of thing. In the past the "real" Swiss economy has coped astoundingly well with huge speculative surges in the franc, and it retains enviable advantages to mitigate such a run-up now.

"Made in Switzerland" conveys 24-carat quality and reliability. Compared with their prickly French and angst-riven German neighbours, Swiss companies have taken globalisation in their stride, and the Swiss labour market is less rigid than the classical continental models of Germany and France. But this time adjustment will be tougher.

With 5 per cent unemployment (stratospheric by Swiss standards, see graph), the Berne government can't simply let the exchange rate take the strain. Unlike Britain, which wonders when the Major boom will end, Switzerland is only now emerging from seven years of next-to-zero growth. In 1998, expansion is put at 2 per cent, but with no sign yet of a pick-up in capital spending and the construction sectors. This Swiss recovery is still young and distinctly fragile.

For the Swiss, like us, the benchmark is the German mark. Over the last 15 years, the franc has revalued against the DM by an average 0.5 per cent a year (though its historic rise against sterling has been far greater, see graph) amid short-term fluctuations of up to 5 per cent either way. More of the same would be tolerable, Jean-Pierre Roth, the deputy chairman of the Swiss National Bank (SNB), implied in an interview this week.

Beyond that however, "We are not ready to accept an appreciation of the franc. The SNB will do everything in its power to prevent the Swiss economy being a victim of monetary instability in Europe."

The prayer of course is that the euro does not generate monetary instability - that it proves to be the DM by another name. If so, "then that's good news," Mr Roth went on, "We'll have the same relationship with it as we had with the mark." But what happens with a weak euro?

These are questions upon which Swiss central bankers do not care to speculate in public. Still less do they want to provoke diplomatic incidents by saying who should join the single currency and who should not.

Plainly though, the SNB would infinitely prefer a narrow euro similar to today's de facto D-mark zone, perhaps augmented by the French franc. Almost certainly, though, the beast will have a more Mediterranean (read Italian) hue. And the Swiss, understandably, are not a little jittery.

Polite as he must be, Mr Roth refers to the "huge fluctuations" in the franc/lira rate in the past. More graphically, and despite Italy's current burst of economic rectitude which has enabled it to meet the Maastricht guidelines, armadas of motorboats crossing Lake Lugano laden with high denomination lira banknotes during Italian crises past are an image etched in Switzerland's financial folk memory. So how to stop a repeat?

The obvious answer is somehow to peg the franc to the euro. But that presupposes Switzerland is going to join the European Union. Such is the goal of the Swiss government, and even the Swiss banks, for all their fears that Brussels regulations will spell the end of their "offshore" status in Europe, are slowly coming round to that view.

But assuming the country settles its current disputes with the EU (in particular over transport and the free movement of people), full membership is inconceivable before 2005 at the earliest. If Britain is a euro "pre- in", Switzerland remains an unqualified "out." The fact that Swiss interest rates are 2 per cent below German ones sends exactly that message. In these circumstances, a peg would be next to impossible.

But if no peg, then what? Exchange controls, in this day and age, are out - as are negative interest rates, which Switzerland used in the 1970s, but which are now considered to discriminate unfairly against those sending money to the country for "legitimate" reasons.

Instead the SNB, like the Bank of England, is putting its faith in a flexible exchange rate which doesn't offer speculators an easy target. On top of that, the SNB has signalled it will provide liquidity if there's a large demand for Swiss francs. In other words, run an accommodating monetary policy and hope you can convince markets there'll be no easy pickings. But at around 1 per cent already, short-term Swiss interest rates don't have much further to fall.

Whatever happens to the franc in the short term, the euro is another harbinger of change in arguably Europe's most change-resistant country. Just as the EU is eroding the meaning of Swiss political neutrality and independence, the euro is gnawing at its financial independence.

The Swiss banks have already set up Euro-SIC, a privately owned institution based in Frankfurt that will function as a euro clearing bank, linking Switzerland with the euro-zone, and ready to start operations on 4 January 1999, the first business day of the single currency.

They realise too their country's long-term future cannot be as a Cayman Islands in the heart of Europe, growing fat on asset management and protecting capital fleeing the euro and prying national tax authorities. The banking industry accounts for 10 per cent of Swiss GDP, but ultimately the strength of the franc depends on a prosperous real economy behind it.

And for Switzerland as for Britain, like it or not, that prosperity will be shaped in good measure by their relationship with the euro.