The Swiss National Bank has pulled the plug on its costly strategy of tying the franc to the euro, plunging already anxious currency markets into a tizzy and threatening to undermine the fraying credibility of central banks.
Thursday's move sent the franc soaring and Swiss stocks plunging. Gold prices shot up as a fresh wave of volatility washed over nervous markets in the wake of the policy reversal, which came without warning.
The repercussions reached across Europe and beyond, hitting currency, equity and gold players as well as Eastern European banks and thousands of borrowers in Poland and other countries in the region laden with mortgages and other low-interest loans denominated in the Swiss currency.
The shift sparked speculation that the Swiss had to move in advance of an expected aggressive foray into quantitative easing by the European Central Bank (ECB).
That would pummel the euro and saddle the Swiss National Bank (SNB) with many billions in additional losses on its ballooning euro holdings.
More than six years after the global financial crisis, the tumult underscores the continuing fragility of financial markets and the risks posed by unprecedented but supposedly temporary central bank actions designed to right their own ships.
"The decision to hold the Swiss franc stable relative to the euro was a very bad one," said currency and commodity watcher Dennis Gartman, publisher of the Gartman Letter.
"The decision to suddenly free it without any sort of hint that they were going to – which would have allowed people some time to get their houses in order – is an even worse decision," Mr. Gartman said.
The SNB's about-face was understandable, he said. He just wishes it had been smarter about it. "They knew that they were facing enormous losses eventually, so they decided to rip the Band-Aid off. But in the process, they ripped off a limb" and needlessly sparked more volatility in the markets.
While abandoning the cap of 1.20 francs to the euro it introduced in September, 2011, to drive down the value of the Swiss currency and boost the country's struggling export sector, the central bank sought to limit the franc's resurgence by driving short-term interest rates deeper into negative territory, to minus 0.75 per cent. This forces speculators to pay more for the privilege of holding the franc.
The bank also signalled its willingness to intervene in future if necessary.
"The SNB appears to be acknowledging that it can't defend its currency from any new ECB attempts to try and weaken the euro … and is trying to mitigate this by launching new measures to try and deter further inflows into its currency," said Michael Hewson, chief market analyst with CMC Markets in London.
But this did little to slow the stampede into the currency, which has long been regarded as a relatively safe harbour in stormy seas. Still, the Swiss central bank had little choice but to reverse gears, because of the heavy damage to its balance sheet from enforcing the cap and the prospect of much worse to come once the ECB launches a massive bond-buying program in an effort to resuscitate the flat-lining euro-zone economy and halt its slide into crippling deflation.
Most ECB watchers expect the bank to make its well-telegraphed move into full-scale quantitative easing as early as its policy meeting next Thursday.
SNB president Thomas Jordan insisted the currency cap had served its purpose and its removal was designed to catch the markets off guard.
"You can't do it in any other way," Mr. Jordan told a press briefing in Zurich. "We came to the conclusion that it's not a sustainable policy."
Skeptics argue that it was never sustainable and that the bank's move was long overdue.
"We venture that the SNB will sooner or later be forced to permit the franc to appreciate," bond and currency expert Jim Grant told readers of his Grant's Interest Rate Observer last September in an article headlined: "The balance sheet that ate Switzerland." The franc, he said, remains "for many the monetary bolt-hole of choice."
That was underscored Thursday when the newly liberated currency immediately skyrocketed against the euro and rose against the greenback.