Switzerland's Central Bank Finally Gets Some Inflation -- In Its Profit

By Brian Blackstone Features Dow Jones Newswires

Switzerland's central bank is finally generating some inflation, at least in its own profit.

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The Swiss National Bank's foreign-currency reserves jumped by 17 billion Swiss francs ($17.04 billion) in October, putting the central bank on track for another banner quarter after earning a record-high profit of 32.5 billion francs between July and September.

The SNB's foreign reserves were 741.5 billion francs last month, the bank said Tuesday, up from 724.5 billion francs in September. Separate weekly data on sight deposits -- which analysts see as a proxy for currency intervention -- have been steady for several months, suggesting the SNB hasn't been adding to its reserves with new stock and bond purchases.

That means the 17 billion franc rise in its foreign reserves reflected valuation gains -- profits -- on its existing stockpile of assets, mostly foreign bonds but also equities.

Tuesday's report is the latest evidence that the SNB's massive wager -- that by purchasing hundreds of billions of francs worth of foreign assets it could reduce the franc's value -- is paying off, both in terms of weakening the franc and pumping up its own finances. A weaker franc raises inflation, which is super low in Switzerland at 0.7%, and helps exporters.

Foreign reserves generate profits in three ways: interest and dividend income; changes to stock and bond prices; and valuation gains when foreign-currency assets are denominated back into Swiss francs. The latter two can also lead to losses. In early 2015, the SNB booked huge paper losses when the franc rose sharply against the dollar and euro.

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But the franc has weakened in recent months, partly because of the SNB's intervention efforts whereby it created francs and used them to buy foreign stocks and bonds -- and better economic activity particularly in Europe, which has raised the euro's value.

Given the size of the SNB's reserves, which exceed Switzerland's entire gross domestic product, even a small weakening in the franc can mean many billions of francs in paper profits. The euro rose nearly 5% against the franc in the third quarter, raising the value of the SNB's 320 billion francs worth of euro assets.

Last month, it was the dollar's turn to inflate the SNB's reserves. It rose over 3% against the franc last month and fetched 1.0006 francs Tuesday. Given that the SNB held 263 billion francs worth of dollar assets at the end of the third quarter, the dollar's rise contributed several billion francs to the rise in SNB reserves last month.

While this is all good for the SNB, a big question remains: what will it do with all this money?

To turn these paper profits into actual francs and bring them back to Switzerland, the SNB would need to sell some of its foreign assets. That would likely strengthen the franc, which is precisely what the SNB is trying to avoid.

And its hands are tied on what it can do with its profits. Whereas central banks like the Federal Reserve transfer most of their profits to their governments, the SNB is in the early stages of a five-year profit-sharing arrangement whereby the maximum amount it can transfer to the Swiss federal and regional governments is just two billion francs a year. That is a tiny share of what it has been making.

Therefore, some of the SNB's profits this year will probably go to its capital provisions with the rest being carried over into 2018.

But the debate in Switzerland is likely to heat up if these large profits persist. Some economists and politicians have already called for creation of a sovereign-wealth fund to manage a portion of the SNB's reserves.

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

(END) Dow Jones Newswires

November 07, 2017 06:56 ET (11:56 GMT)