LONDON With the Swiss National Bank's foreign currency reserves at record highs, investors are growing anxious about its ability to keep the Swiss franc from appreciating further against the euro, amid heightened political risk in Europe.
The price of hedging against big price swings over the next two months in the Swiss franc/euro exchange rate -- a rate kept steady by the SNB that should theoretically therefore not be as volatile as freely floating currencies -- this week hit its highest since the aftermath of last year's Brexit vote EURCHF2MO=.
Mindful of the central bank's sudden removal of the Swiss franc cap in January 2015, which delivered one of the biggest shocks to financial markets of the past decade, investors worry the SNB's sizeable interventions in the foreign exchange market are unsustainable and could be suddenly halted.
"Every investor has still in mind the decision of January 2015, and they don't want to be caught on the wrong foot," said Maxime Botteron, economist at Credit Suisse in Zurich.
"So they are anticipating less accommodative (policy), or a reduction in intervention."
The safe-haven Swiss franc EURCHF= has climbed almost 2 percent since early December, despite the SNB's efforts to keep it capped, on worries that political risks in Europe -- notably a possible victory by anti-euro Marine Le Pen in France's April-May presidential election -- will spur a flight to safety.
Numbers released this month showed the SNB, which meets on Thursday, defended the Swiss franc in February with the biggest intervention since Britons unexpectedly voted in June to leave the European Union.
It bought more than 24 billion francs' ($24 billion) worth of foreign currency, growing its reserves by almost 4 percent to a record 668 billion francs, or around 115 percent of GDP.
"GO-TO" POLITICAL RISK TRADE
Though the SNB no longer has a formal cap on the euro/Swiss franc exchange rate, some analysts say the 1.06 franc per euro level is now effectively a "soft floor" that has become "hard" in the mind of investors.
"Euro/Swiss has become the 'go to' trade to hedge European political risk," said Peter Rosenstreich, head of market strategy at online bank Swissquote.
"I'm not sure that they wanted something as clean as the 1.06 franc level but that's sort of what they've got, and that's the risk," he said. "Whether that's real or perceived ... policy expectations in markets have almost the same sort of force (as policy itself)."
UBS Wealth Management's head of currency strategy Constantin Bolz said the situation now was quite different from January 2015, when the SNB was looking at the prospect of a European Central Bank quantitative easing programme that was set to drive the euro down sharply and had no clear end in sight.
Therefore, Bolz said, unless Le Pen wins a surprise victory in the French election, the SNB will continue to intervene to stop the franc from appreciating further until then, however much pressure is put on it due to euro weakness and demand for safe havens.
Germany holds an election in September, and there is a chance that Italy will also go to the polls this year.
"After last year's results, it would be unwise to ignore the risks of these upcoming votes, and that is what is driving demand for francs and making the SNB nervous," said Ursina Kubli, FX strategist at Swiss private bank J. Safra Sarasin.
(Writing by Jemima Kelly; Reporting by Ritvik Carvalho and Jemima Kelly in London, and John Revill in Zurich; Editing by Nigel Stephenson and Catherine Evans)