The Outsiders

By Brian Blackstone Features Dow Jones Newswires

The European Central Bank is expected to decide Thursday whether to scale back its nearly three-year-old asset-purchase program, a potential milestone for global central banking. Yet smaller central banks in Europe, particularly Switzerland, have in recent years been forced to take their own extreme measures to protect their economies. They printed hundreds of billions of dollars' worth of their currencies and used them to buy stocks, bonds and cash around the world, supporting global asset markets in the process. They have already started scaling back some of these efforts.

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Inflation in these countries remains largely subdued despite these extraordinary easing efforts, though ultra-low interest rates may be forming housing bubbles in parts of Switzerland and Denmark.

SWITZERLAND

Switzerland's economy buckled, but didn't break, after the 'franc shock' in January 2015.

The ECB's decision in January 2015 to launch a massive program of bond purchases, known as quantitative easing, hit its neighbors hard--none harder than Switzerland. Yet the rich Alpine country appears to be one of the earliest beneficiaries of the ECB's expected tapering of those purchases, with a weaker franc boosting exports.

Like other European countries outside the eurozone, Switzerland is heavily influenced by ECB policies affecting exchange rates, exports and inflation. Switzerland took drastic action even before the ECB announced its program, cutting its deposit rate into negative territory in December 2014 and unexpectedly abandoning a longstanding floor on the euro's value against the franc one week before the ECB decision.

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A further reduction in the deposit rate to minus 0.75% wasn't enough to keep the euro from plunging as much as 30% against the franc the day the floor was lifted, threatening the export-dependent economy where roughly half of exports go to the eurozone.

Despite fears of recession and deflation, Switzerland largely weathered the hit from the stronger franc, which has slowly weakened since early 2015. But this has come at a high cost for the Swiss National Bank, which had to intervene massively in currency markets by selling francs to purchase foreign stocks and bonds in a bid to weaken the currency and keep Swiss exports competitive. That has boosted its already high level of foreign assets by about 240 billion francs ($242 billion) since 2015 to around $750 billion.

Economic growth weakened from nearly 2% on an annual basis in early 2015 to just 0.3% in the second quarter. But help may be on the way for Switzerland: The franc has weakened against the euro since the middle of the year and started to weaken against the dollar, too. The SNB has acknowledged this, saying in September that the franc was "highly valued, " a slight softening of its longstanding warning that it was "significantly overvalued."

Negative interest rates and foreign-asset purchases haven't yet led to an outburst of inflation, which was 0.7% on an annual basis last month. But a recent report by UBS said the Swiss real-estate market was in the "risk zone" for a bubble.

CZECH REPUBLIC

The Czech Republic adopted a currency target even before the ECB launched QE, and after large-scale interventions was able to drop its peg to the euro without much disruption.

The Czech National Bank took a page from Switzerland's playbook when, faced with a strong currency amid concerns over the euro, it set a peg on the koruna's value against the euro in November 2013.

The ECB's asset-purchase program put upward pressure on the Czech peg, which was set at around 27 koruna to the euro. It spiked in the aftermath of that decision, forcing the CNB to spend vast sums intervening in currency markets to weaken the koruna.

The Czechs had a particular problem: trade with Germany, which the CNB calls "crucial." A weaker euro made Czech products less price competitive in Germany, threatening the country's trade with Europe's biggest economy.

In some ways, its currency action was riskier than Switzerland's because the koruna doesn't have the same safe-haven status as the franc. That exposed the Czech central bank to significant currency losses if the peg failed.

Yet the Czechs largely weathered the storm, and while the inflation rate sank after the ECB launched QE, it gradually increased to 2.7%--within the CNB's target of 2% with a one-percentage-point band on each side.

And they were able to exit their peg earlier this year without causing the same disruptions as Switzerland. Czech policy makers telegraphed the move well in advance of formally dropping the peg in April, and haven't intervened since May.

In August, the CNB raised interest rates, a rarity in Europe and beyond in recent years.

Economists at ING Bank call another rate increase next month a "done deal."

DENMARK

Denmark's negative interest rates helped keep its currency within the target band against the euro, but fueled a housing boom in the process.

The Danish central bank faced a different dilemma from that of its Swiss, Czech and other counterparts because it doesn't have an inflation mandate. Rather, its sole responsibility is to keep its currency, the krone, in a tight exchange-rate band against the euro.

Policy makers there reacted quickly to the ECB's launch of QE, slashing their already negative deposit rate to minus 0.2% days before the announcement and reducing it further in subsequent weeks to minus 0.75%. Last year, they nudged it higher to minus 0.65%.

They also suspended bond issuance and intervened massively in the foreign-exchange market, all with the aim of keeping the euro's rate against the krone within 2.25% of 7.46.

Denmark's economy has strengthened since early 2015. Its central bank expects economic growth of 2.3% this year, followed by 1.8% next year and 1.7% in 2019. "This implies that the Danish economy will be in a boom with larger pressure on production capacity and labor resources," it said last month.

But it isn't out of the woods yet. Low interest rates prompted a boom in the housing market--particularly in its largest city, Copenhagen--as some home buyers' mortgage rates turned negative, meaning they were paid to borrow.

"In Copenhagen prices continue to rise at a worrying pace. Here the price level seems to be higher than what the development in disposable income and interest level can account for," the central bank warned in a report last month.

Write to Brian Blackstone at brian.blackstone@wsj.com

(END) Dow Jones Newswires

October 25, 2017 05:37 ET (09:37 GMT)