August 23, 2011 / 5:19 PM / 8 years ago

SNB's target rate poised to turn negative

ZURICH (Reuters) - The market interest rate the Swiss National Bank targets looks set to turn negative this week, sending jittery investors seeking to safeguard their funds in Switzerland into uncharted waters.

A Swiss National Bank (SNB) logo is pictured on the SNB building in Bern July 29, 2011. REUTERS/Pascal Lauener

The key rate has been trending towards zero for several days but it has never before been negative, making it hard to gauge exactly how market participants will react to the prospect of negative returns.

However, there are indications a negative fixing is unlikely to cause a major disruption for markets for now.

To weaken the record-strong franc, the Swiss National Bank’s (SNB) strategy is to pump liquidity into markets to push down interest rates, making Swiss-franc denominated assets less appealing. To do so, it has cut its target for the 3-month Swiss franc London Interbank Offered Rate (LIBOR) to “as close to zero as possible.”

The two-month franc LIBOR turned negative on Tuesday and the three-month rate looks set to follow.

LIBOR is calculated daily by banks in London, and shows how much they think they would have to pay to borrow unsecured funds overnight. Rates are published between 11:30 a.m. and noon British time each day.

A negative LIBOR means that the borrowing bank, in theory, would be paid by the lender to take the money.

Although a negative LIBOR could make lending unattractive at a time of heightened stress, market participants said the phenomenon would not last long and a recent Swiss federal debt auction had shown investors were so keen on Swiss assets they were willing to accept negative returns.

The high amount of liquidity in the money market due to the SNB’s actions has also reduced the need for interbank lending, thereby pushing the three-month LIBOR towards zero and the two-month into the red.

“I regard these negative rates as an anomaly, because investors are looking for safety,” said Ronald Plasser, portfolio manager at Bankhaus Schelhammer & Schattera in Vienna. “I don’t think it will last.”

The SNB’s liquidity-boosting measures have already turned various short-term rates negative, such as Euro-Swiss futures.

“We know that the system will work if rates are below zero,” one trader said, adding the three-month Swiss franc LIBOR would not go deeply into the red, given the amount of liquidity in the market and strong demand for the franc. “A few basis points below zero but not much more.”

FURTHER MEASURES

The SNB was sharply criticised for running up huge losses during its 2009-10 intervention to tame the franc. It is now trying to weaken the franc by boosting sight deposits, accounts commercial banks hold with the central bank, and by using foreign exchange swaps.

The franc has weakened about 9 percent from its August 9 record peak against the euro, when it nearly touched parity, in a sign that the SNB’s easing measures are working.

Any escalation of the euro zone debt crisis or of global recession fears could cause the franc to rise again and retest that high, currency strategists say.

If the SNB still wants to steer clear of intervening in the spot market and opts instead to weaken the franc via money market operations, it could try shortening the duration of the foreign exchange swaps or start charging Swiss banks for clearing foreign banks’ funds.

In the case of foreign exchange swaps, using shorter maturities would more closely target the spot exchange rate.

“Speculators who are long Swiss francs would feel it more,” a trader said.

By charging banks for clearing funds, the SNB could also try to reduce the appeal of the Swiss currency for players willing to accept the opportunity cost of holding their assets in cash, if the central bank’s mandate allows it.

There is a precedent: Bank of New York Mellon Corp (BK.N) is charging some of its big customers a fee for large deposits, as global economic turmoil drives them to sell riskier assets and move the proceeds to deposit accounts.

But ultimately these actions may not work as they would not dent the franc’s safe-haven status.

“In my opinion its not a question of yield for the banks holding francs — it’s the insurance,” one trader said, adding that what was really needed was a resolution of both the euro zone debt crisis and economic woes in the United States.

Editing by Susan Fenton

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