Mr Roth remarks on the euro and Swiss franc: two sister currencies?
Speech by Mr Jean-Pierre Roth, Vice-Chairman of the Governing Board of the Swiss National Bank,
at the Swiss Business Association Annual General Meeting, Singapore, 24 February 2000.
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For more than a year now, the euro has been a reality. It has crowned a decade long process of
monetary integration in Europe. The introduction of a common currency in eleven closely related, but
independent countries is an unique experiment. It is still too early to assess all the far-reaching
implications of this monetary revolution. Therefore, the thoughts and remarks I am going to express
today can only be intermediate and provisional.
1. Consequences of the euro for the Swiss economy
Switzerland is not part of the Monetary Union. It is nonetheless deeply integrated in its European
environment through its geographic situation and its strong historical, cultural and economic links with
Europe. Over 50% of our exports go to countries of the euro-zone, while 70% of our imports come
from there. But, besides that, Switzerland has strong traditional links overseas, too. The US, Canada
and Japan account for 10% of our imports and 15% of our exports while emerging markets represent
4% and 10% respectively. Although concentrated on Europe, our foreign trade is geographically more
diversified worldwide than that of other small open European economies such as Austria, the
Netherlands or Belgium.
For the first time in its history, Switzerland is surrounded by countries all sharing the same currency.
Even without being a member of the Union, it is affected by this new monetary situation. De facto, our
trade with Europe is already taking place in one currency only - the euro - because the parities of the
former national currencies have been definitively locked. That means that our foreign trade is less
diversified by currencies than earlier and that fluctuations of the SF/euro exchange rate have an even
stronger impact on the Swiss economy than the former SF/DM or SF/FF exchange rates. At the same
time, a common monetary policy for Europe is likely to lead - over time - to a stronger
synchronization of business activity in the EMU member states. This, in turn, means that the impact of
the European business cycle on the Swiss economy will become more even and thus also stronger.
More than ever, Switzerland's economic destiny will be linked to that of Europe.
Today, Switzerland benefits already from the technical simplification induced by the substitution of
ten different currencies by a single one. Monetary unification brings advantages to internationally
oriented firms as it simplifies their foreign currency management and their accounting procedures.
From the year 2002 onward, when the euro will exist in the form of cash, the single currency will
make things even easier for a broad public, not only for the Europeans, but also for every Swiss
travelling through the euro-zone. At that time, the euro will probably also be easily accepted for
payments in Swiss border regions and tourist areas.
As final advantage, the single currency greatly enhances market transparency and stimulates
competition. On the one hand, Swiss importers can now directly compare euro denominated offers
from different countries. On the other hand, exporters can less easily differentiate prices according to
the market destination of their products. In the long run, transparency will promote efficiency for
EU-members and non-members. The almost daily news about mergers and acquisitions in Europe is
an expression of the ongoing fight for a favorable position on the unified European market.
2. Extraordinary stability of the Swiss franc/euro exchange rate in the past ...
After these remarks on the general consequences of the euro for Switzerland, let us now turn to the
more specific, but nonetheless central, question of the exchange rate between the Swiss franc and the
euro. As already mentioned, the exchange rate between the Swiss franc and the euro is of crucial
importance to the Swiss economy. So far, the relation between the two currencies has been remarkably
stable. Since the introduction of the single currency, the Swiss franc/euro exchange rate has fluctuated
in an extremely narrow band of only 2%. Thus, exchange rate volatility has until now been even lower
than the 8% volatility observable between the Swiss franc and the Deutsche mark during the three
years preceding the monetary unification.
The extreme stability in the exchange rate has surprised many observers, including the Swiss National
Bank itself. It has led to the notion of "sister currencies", the euro being the big sister and the Swiss
franc following her everywhere like a shadow. But is the Swiss franc really the euro's little sister? Let
me discuss this question in detail.
If one examines the reasons for the extraordinary stability in the exchange rate, one quickly finds that
convergence in fundamentals has played a central role. Both Europe and Switzerland have suffered
from slow growth in the 1990s and from deflation fears in the aftermath of the international financial
crisis of 1998. Rising unemployment and weak economic activity led the ECB and the SNB to adopt
an expansive monetary stance and to cut interest rates. Broad similitude in business cycle and
monetary stance has created conditions leading to an almost fixed exchange rate between the euro and
the Swiss franc. At the same time, converging fundamentals explain why both currencies have been
equally weak against the US dollar: the American business cycle is well in advance of the European
and Swiss business cycles, requiring a different policy response from the Fed.
While fundamentals play a key role in explaining long run exchange rate developments, political
factors can also be of some importance in the short run. By political factors I mean, for example,
elections, government crises, political conflicts or new legislation, but also the relation between the
government and the central bank, and the credibility of both. In 1999, these widely defined political
factors may have played some role for the relation between the euro and the US dollar. The conflict
between the former German finance minister Lafontaine and the European Central Bank, the European
undecidedness in the face of the Kosovo conflict, and the plans for a harmonization of taxes on interest
payments, for example, may have contributed to the weakness of the euro against the dollar. In
addition, the not always clear communication strategy of the European Central Bank concerning its
views on the exchange rate of the euro may also have created some uncertainty.
However, it is puzzling to see that the relation between the Swiss franc and the euro has not been
disturbed by these factors. It may be that the markets perceived Switzerland as so strongly integrated
in Europe that they almost forgot that the Swiss franc is an independent currency. Or, they believed
that the Swiss National Bank, as declared in the early and uncertain days of the introduction of the
euro, would not tolerate a sharp appreciation of the Swiss franc. Expectations of a SNB reaction
certainly played a role.
In my view, a further factor may explain the greater stability of the Swiss franc vis-à-vis the European
currencies. One cannot exclude that the emergence of a large market for the euro has had a structural
impact on the demand for Swiss francs. Today, the currency diversification of international portfolios
occurs between blocks (dollars, euros, yen and Sterling). Given its size and its traditional low volatility
vis-à-vis the DM, the market for Swiss franc denominated assets does not offer an attractive way to
counterbalance the risks born by large holdings of key currencies. Our currency is thus less demanded
as reserve currency and less involved in speculative capital movements. This is basically good news
for the Swiss economy.
3. ... and what about the future?
What conclusions can be drawn from the past? Will the Swiss franc remain stable vis-à-vis the euro, or
will we see a more independent development of our currency? Again, the answer to this question will
depend crucially on economic fundamentals in Switzerland and in the euro-zone. In both areas, the
economy is now recovering from the recession, following a steady upward path. The expected growth
rates for this year amount to 2.2% for Switzerland and 2.9% for the euro-zone. The central question
for the exchange market is to what extent the economic upturn could endanger price stability, and what
kind of central bank's reaction can be expected.
3.1 Uncertainty about lasting convergence in European and Swiss fundamentals
While Europe is now growing faster, it still suffers from an unemployment rate of roughly 10%. At
first sight, one might think that this big labor reservoir would allow the economy to grow without
tensions on the labor market and without large wage adjustments. Inflation would remain subdued, and
there would be no need for an all too restrictive monetary policy. This, however, is only the "first
sight" scenario. European unemployment is largely structural, meaning that although there is a
demand for labor on the part of the firms, this demand is not necessarily matched by the supply on the
labor market. Under these circumstances, the labor market could constitute a bottleneck for growth
and lead to inflationary pressure. To prevent inflation from rising, the European Central Bank would
have to further increase interest rates. Clearly, structural adjustments are of the essence in Europe. In
the absence of flexibility, the unemployment rate cannot be lowered significantly and doubts exist
about the actual room of maneuver of the monetary authorities.
Expected growth for Switzerland, on the other hand, looks quite moderate by international standards.
Thus, one might think that there is little danger of inflation and that the Swiss National Bank should
further support the seemingly fragile economic upturn. A look at the labor market, however, shows
another picture. Unemployment has fallen steadily since the summer of 1997 to a low rate of 2.3%
only. Its recent increase to 2.6% is due to seasonal factors. Moreover, there are already clear signs of a
shortage on the labor market. Stronger growth could thus fuel the well-known wage-price spiral.
Under these circumstances, a further tightening of monetary policy is a realistic hypothesis.
To make things even more difficult, there is a high degree of uncertainty concerning the development
of labor productivity in both Europe and Switzerland. The rise in labor productivity is usually seen as
the main factor behind the spectacular performance of the US economy, characterized by high growth
and low inflation. Will productivity now also start rising in Switzerland and Europe? Where will it rise
more? In Switzerland, where the labor market is more flexible and structural reforms are more
advanced, or in Europe, where the large common market and the single currency are expected to break
up old structures?
We have good reasons to believe that there is a potential for non-inflationary economic growth in
Switzerland. Investment has been strong in 1998 and in the first part of 1999, deregulation and
competition have made spectacular progress, large-scale adjustments have taken place in various
economic sectors and more flexibility is now accepted in the labor market. Some adjustments in the
interest rate have been made in order to restore a more neutral monetary stance. In one word, the
degree of competitiveness of our economy is stronger today than it was 5 or 10 years ago, production
capacities have not been fully exhausted and monetary conditions have been adjusted. Switzerland will
thus benefit from the recovery in Europe without major risk of inflationary pressures.
Indeed, the assessment of the future stability in the exchange rate between the Swiss franc and the euro
depends crucially on what will happen in Switzerland and in the surrounding countries. If the
convergence in fundamentals goes on, the exchange rate should remain relatively stable; otherwise
some adjustment will be needed. I am convinced, however, that the exchange market will not behave
irrationally. Following the pattern of the DM/SF relationship of the past, it will not depart substantially
from what fundamentals would suggest.
3.2 Political uncertainties
What about the political factors influencing the exchange rate? I would like to mention here two major
themes that could possibly affect the relation between the Swiss franc and the euro.
The first factor is the uncertainty about Switzerland's future policy towards Europe. As you may
know, the Swiss people rejected Switzerland's membership in the European Economic Area (EEA) in
December 1992. This vote was regarded as an anti-EU signal by the government, which has since then
shelved its plans for adhesion to the EU. As an alternative, Switzerland has negotiated Bilateral
Agreements with the EU in order to gain free access to the EU internal market for goods and services.
The agreements need to pass a popular vote next May. The prospects for an adoption of the
Agreements are good. Sooner or later, however, the question of Switzerland's accession to the EU will
be considered again. Should the Swiss people still favor a Switzerland outside of the EU, then room
for monetary independence will remain.
The second political factor is the uncertainty about the EU enlargement. There is a long list of Eastern
European and Mediterranean countries pushing into the EU. Of course, EU enlargement will be a
progressive step-by-step process. Nevertheless, it is uncertain today how an enlargement will change
the EU's face in the future. How will these countries be integrated? How will the decision-making
process inside the EU be affected? And finally, how will the EU enlargement be financed? All these
open questions constitute a potential risk factor for the euro.
4. Conclusions
Looking back at the first 14 months of the euro from a Swiss perspective, the most striking
observation is the extraordinary stability of the Swiss franc/euro exchange rate. A detailed analysis
shows that this stability was due to a high degree of convergence in economic fundamentals and in the
monetary reaction of the two central banks. Thus, solid economic reasons have been behind this
stability and not some artificial strategy of currency pegging implemented in secret by the SNB. In the
future, the exchange rate should evolve depending on the development of the fundamentals - in
Switzerland and in the euro-zone - and on the answers to some important political questions. Exchange
rate stability, on the scale that has been experienced so far, is not guaranteed to last forever. However,
the risk of erratic movements seems limited because the presence of large currency blocks has lowered
the attractiveness of the Swiss franc as reserve currency.
Nevertheless, I would hesitate today to qualify the euro and the Swiss franc as "sister currencies". If
you have a sister, she remains your sister for life and not just in case of common interests. We should
rather consider these two currencies as travel companions: they share the same objective - a sound
macroeconomic development - and follow the same road towards price stability. It is up to their
relative fitness to see whether they will continue hand in hand.