European shares dropped to their lowest level in more than two years on Tuesday night after the single currency’s debt crisis forced Switzerland to take emergency action to cap the franc’s rise on the world’s foreign exchanges.
Prompting fear of the outbreak of a currency war, the Swiss central bank said it would do whatever was necessary to halt the hot money flow that threatens one of the world’s richest countries with recession and deflation. The move to set a limit of 1.20 swiss francs to the euro came at the start of another turbulent day in which shares were under pressure, United States and German bond prices rose and the Norwegian krone become the safe haven of choice for currency investors burnt by the Swiss decision to reverse the appreciation of the franc, which lost a record 9% of its value within 15 minutes of the announcement.
Jeremy Cook, the chief economist at currency brokers World First, said: “That was the single-largest foreign-exchange move I have ever seen. This is intervention on a grand scale. It turns up the heat on the eurozone and other economies which have benefited from weakening their currency in the past couple of years.”
Chris Turner, the head of foreign exchange strategy at ING, said the Swiss central bank’s decision marked “a major new round in the currency war”. He suggested the next country to act could be Japan, which is worried about the impact of a rising yen on its export-dominated economy. “Could not Japan also set a minimum US dollar exchange rate as a means to battle deflation?” Turner said.
In a statement the Swiss National Bank said: “The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development.” It added that it was prepared to intervene in “unlimited quantities” to enforce the 1.20 limit and was “aiming for a substantial and sustained weakening”.
In recent months currency investors have been deserting the euro in favour of the franc amid growing anxiety about the ability of Europe’s leaders to tackle the sovereign debt crisis that has resulted in bailouts for Greece, Ireland and Portugal and forced the European Central Bank to act to prevent Italian and Spanish borrowing costs spiralling.
A general strike in Italy added to Tuesday’s jittery mood, with markets also waiting for the decision by Germany’s constitutional court on the legality of the bailouts for Greece, Ireland and Portugal. The Norwegian krone hit an eight-year high as investors sought a new currency refuge after Switzerland’s move to curb the franc, posing a fresh dilemma for a Norwegian central bank that would like to raise rates to curb inflationary pressure.
Gold was last night trading at just less than $1 900 an ounce amid predictions that it could test the $2 000 level in coming weeks.
Speaking to the British Parliament’s treasury select committee, Jim O’Neill, former chief economist at Goldman Sachs, said the central problem facing the eurozone was that too many countries had been allowed to join the single currency. He described the situation as “fragile and tricky” and said that the only way the euro could survive was through political unity and a single, central eurozone treasury.
European banks were the worst performers on a day in which the pan-European FTSEurofirst 300 index of top shares closed at its lowest level since July 2009. The price of credit-default swaps — insurance against a borrower being unable to repay — on the United Kingdom’s bailed-out banks, RBS and Lloyds Banking Group, hit new highs. It now costs about £350 000 to insure £10-million of the banks’ bonds against default for a year. Investors are worried about a range of problems facing the banks, from European debt exposure to problems raising funds and potentially huge bills looming from United States lawsuits.
Shares in London posted modest gains after two days of heavy falls, with the FTSE 100 index closing 54 points higher at 5 157. However, Wall Street’s Dow Jones industrial average was down 200 points in early trading, in spite of a better-than-expected performance by the US service sector in August.
Financial markets believe the slowdown in global growth will prompt the US Federal Reserve and the Bank of England to pump more money into their economies and may persuade the European Central Bank to reverse the two interest-rate hikes announced earlier this year.
Amid evidence that the global private sector is growing at its weakest pace since August 2009, the Organisation for Economic Co-operation and Development is likely to cut estimates for global growth this year and next when it publishes forecasts in Paris tomorrow. JP Morgan’s global all-industry output index, which is based on the results of purchasing manager surveys of thousands of companies worldwide, edged down from 52.5 in July to 51.5 last month.
“Growth of global output eased to its weakest in the recovery to date,” said David Hensley of JP Morgan. “Although manufacturing was the main drag, the service sector fared only moderately better.” —