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[LONDON] Thomas Jordan's struggle to control the franc shows just how unforgiving foreign-exchange markets can be.
The first two-month drop against the euro since April last year hasn't convinced traders to give up on another rally in Switzerland's currency. Options still show a better-than-even chance it'll appreciate to parity in the next year, from 1.06 per euro on Tuesday in London.
The persistence of speculation on a stronger franc is challenging the ability of the Swiss National Bank president to curb its appeal using negative interest rates and market intervention. It's a cautionary tale for other countries that are trying to control their exchange rates with pegs, such as Denmark, or ceilings, such as the Czech Republic.
"What we've learned from the SNB is that the idea that the central bank has unlimited power to prevent currency strength is obviously wrong," said Petr Krpata, a London-based foreign- exchange strategist at ING Groep NV, who sees the franc trading one-to-one versus the euro within six months. "There's a clear limit to how much they can intervene."
The SNB is grappling with the fallout from a stronger franc after abandoning its cap at 1.20 francs per euro in January, sending it surging to a record. The currency's gains are hurting the economy, with analysts predicting a report Wednesday will show consumer prices fell for a ninth straight month in July.
Mr Jordan received a timely reminder of this last Friday, when the SNB reported a record first-half loss, which briefly sent the franc soaring amid speculation officials were running out of ammunition to curb the currency's gains.
The SNB is limited in how much it can intervene by selling francs because that bulks up its balance sheet with foreign exchange, creating upward pressure on its currency when it eventually comes to sell its holdings, according to Commerzbank AG.
"Maybe they can contain franc strength in the short term but we know they won't be able to in the long term," said Thu Lan Nguyen, a strategist in Frankfurt at the German lender, which sees the franc reaching parity with the euro by year-end. "They'd have to start intervening, and then we're back in the vicious circle. They intervene, the balance sheet increases, they don't want that and they stop. And euro-franc collapses again."
Mr Jordan told Bloomberg Television in June that the franc was overvalued and pledged to intervene in markets where necessary.
For the past two months, the currency has gone his way, slumping 2.7 per cent against the euro as Greece moved closer to a bailout agreement, damping demand for a heaven. It's the biggest back-to-back monthly loss since September 2011, when the SNB established the exchange-rate cap after investors fleeing Europe's debt crisis sent the franc soaring to within 1 per cent of euro parity.
Even so, the franc remains 12 percent stronger than the abandoned ceiling and is the best-performing major currency this year.
Options imply a 52 per cent chance of it strengthening to 1 per euro in the next 12 months, and a 69 per cent probability of that happening in two years, data compiled by Bloomberg show. It was at 1.0619 per euro as of 9:40 am London time.
Since the SNB abandoned its exchange-rate ceiling, investors have put the Czech Republic's currency cap in the line of fire. The Eastern European nation has needed to intervene in recent weeks to keep its koruna weaker than about 27 per euro.
Switzerland's example shows what's at stake. The strong franc has helped drive the economy to the brink of its second recession in six years as exports become less competitive. In another sign all is not well, prices of consumer goods dropped 1 per cent last month from a year earlier, according to analysts surveyed before this week's report.
"The SNB seems to be losing power to fight the strong franc," said Ipek Ozkardeskaya, a strategist at trading and advisory firm London Capital Group Ltd who predicts the exchange rate versus the euro will stay within 1.03 to 1.05 in the next six months. "The market never forgives. As soon as the market discovers a weak point, it will take advantage. This is the rule of this game."