The costly battle that smaller European central banks have waged against their own strong currencies may have turned a corner, thanks to the strengthening euro.
Increased confidence in the eurozone, both politically and economically, has raised the euro's value against a broad swath of big and small currencies, including some of its neighbors. Amid these improved prospects for Europe, central bankers in Switzerland, Denmark and the Czech Republic have dramatically scaled back their purchases of foreign currencies in recent months.
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The Swiss National Bank's foreign-exchange reserves--accumulated on a massive scale since 2012--dipped slightly last month to 693.5 billion Swiss francs ($721 billion), the SNB said Friday. The figures suggest the central bank has pulled back on its currency intervention efforts.
Denmark hasn't intervened in markets since March, according to central bank data. Data from the Czech central bank showed currency intervention of just EUR653 million ($745 million) in April, down sharply from March.
This is in contrast to the first quarter, when these banks cumulatively added tens of billions of dollars' worth of foreign currency to their balance sheets. By creating new Swiss francs, Danish kroner and Czech koruna and using them to buy foreign currency assets, these central banks hoped to weaken their own currencies and protect exporters while boosting inflation.
Their ability to step back is a byproduct of the broader normalization occurring among big central banks. The Federal Reserve has raised rates twice this year and is expected to do so again before year-end. The European Central Bank has reduced its quantitative easing program, and officials have sounded more positive about the bloc's economic outlook, even though its deposit rate is still negative.
This has the potential to reduce demand for assets in countries such as Switzerland, whose currencies tend to benefit amid uncertain times in the global economy.
"The Danes and Swiss are all at the mercy of large central banks. Sometimes they lose, like when the ECB cut rates into negative territory and sometimes it works in their favor," as is the case more recently, said Peter Rosenstreich, head of market strategy at Swissquote Bank.
Switzerland has battled the strong franc since the euro crisis intensified in 2010, prompting its central bank to spend vast sums intervening and, eventually, setting a ceiling on the franc's strength in 2011. When it abandoned that cap in early 2015, it was forced to step up its intervention.
Denmark, meanwhile, has a target range for the euro-kroner exchange rate. The Czech central bank had a euro target for a while, but dropped it in April.
The euro traded at just under 1.10 Swiss francs early Friday, near a one-year high. The euro fetched 7.44 kroner--which is near the middle of the Danish central bank's target range--and 26.1 Czech koruna, just slightly weaker than when the koruna target was in place.
A strong currency brings many economic benefits. It reflects the confidence global investors attach to assets of countries such as Switzerland, which is known as a haven. It raises purchasing power and may make key imported commodities like oil less expensive.
But when it is too strong, the economy may slide into persistent consumer price declines known as deflation, which weakens consumption and investment. A strong currency also typically damps exports.
And the exchange rate effects extend beyond exports and consumer prices. The Czech Republic is a key manufacturing hub in sectors like automobiles and thus benefits from low costs. Switzerland is home to global corporate powerhouses like Nestlé SA and Swatch Group AG which generate a significant share of their revenue from overseas but report their earnings in francs.
Switzerland's central bank "is breathing a sigh of relief," said Mr. Rosenstreich.
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(END) Dow Jones Newswires
July 07, 2017 05:50 ET (09:50 GMT)