The SNB peg was announced three years ago today at 0800 GMT.

At about 0400 GMT, the Wall Street published this story. Most people though the SNB would wait another day before doing anything because their regular meeting was scheduled on Sept 7 but the story or something else may have prompted them to act sooner.

If you saw the story, what would you do:

Long-time ForexLive reader Rance knew what to do after he saw the story here.

We really do have the most savvy readers!

We really do have the most savvy readers!

Rance later in that day reported that he came away with a 700-pip gain on a EUR/CHF lot.

Switzerland Weighs A Cap on Franc

Negative interest rates and a month-long campaign by Switzerland’s central bank to flood the market with Swiss francs failed to hold the currency back for long. Now, with the franc again on the path towards parity with the euro,a growing number of exporters and politicians alike are leaning on the Swiss National Bank to take more measures.

Having rejected an outright peg as too far-fetched, many favor a flexible pairing of the franc and the euro. Rather than committing to maintaining a stable exchange rate with the euro that would require the central bank to intervene even when the franc weakens, the central bank would instead set a floor for the euro/franc exchange rate.

The bank would only have to intervene when the currency pair risks reaching the floor, selling francs and buying the euro, assets in euros such as German bonds, or even dollars.

Economists agree that as a prerequisite for such a strategy to work, investors need to be convinced that the central bank will go through with it. Opinions are split, however, on whether it stands a chance of success.

“A floor is an interesting option,” said Julien Manceaux, an economist at ING in Brussels. “The advantage is that you go in just one direction.You’re just avoiding that it appreciates too much and you can let it go when the floor isn’t reached.”

There is a precedent here. In 1978, the SNB successfully fought to make the franc fall against the Deutsche mark, which was slumping at the time, by selling francs for U.S. dollars. The franc fell 20% against the mark within three weeks.

“It took a couple of days to show that the SNB was serious about its unlimited intervention, but then the strategy worked fine,” said Tobias Straumann, an economic historian and professor at the University of Zurich.

Times are different now, though. Foreign-exchange markets were much smaller then, and in pushing the franc lower against the Deutsche mark, the SNB was only dealing with the currency of one country, rather than with the euro, which represents half of Europe. More importantly, the policy triggered inflation. Switzerland’s inflation rate jumped to 5.15% in 1979 from 0.7% in late 1978. Inflation stayed around 5% and higher for years, only falling back to 2.1% in 1983.

Economists have warned that adopting a similar policy today with the euro may cause inflation. The central bank would have to effectively print money, creating more problems for Switzerland’s economy than it would solve.

The Swiss National Bank’s primary goal is to ensure prices at home remain stable. Defending a link to another currency would require it to change its focus and instead ensure that the currency remains stable vis-à-vis the euro. While this would help exporters, the ensuing rise in inflation would hurt all industries, the government and consumers. In a country that has seen inflation rates below 1% for most years during the past decade, inflation would be an unwelcome import for the retirees and the poor.

Linking the currency to that of a region with higher interest rates would also lead to higher domestic interest rates, driving refinancing rates higher for companies and individuals and pushing up rents for the 70% of the populace that don’t own their own property.

And defending the floor could become costly if market participants try to test it. The SNB would have to print and sell Swiss francs, potentially doubling and tripling the amount of foreign currencies on its balance sheet, according to Nuno Fernandes, professor at IMD in Lausanne.

China is a case in point, as one of the few examples of a country with a strong currency that is linked to a basket of foreign currencies.

Its experience isn’t encouraging. As a result of its efforts to hold down the yuan, the Chinese central bank’s balance sheet has become bloated with foreign-exchange reserves. China now holds around a quarter of all foreign-held U.S. Treasurys. Selling a significant proportion of them would rapidly drive prices lower. In effect, the policy binds China to the fate of the U.S. economy and the whims of a starkly divided government.

Politicians and exporters believe the Swiss bank can avoid inflation, and bring relief to exporters, by making its policy temporary.

But the SNB has no crystal ball on what will happen to any foreign-exchange holdings it will amass, making this a strategy that isn’t without its perils.