By Swaha Pattanaik and Jamie McGeever
LONDON, March 12 (Reuters) - Switzerland on Thursday broke a taboo among developed nations by trying to weaken its currency to help its economy, a policy that could trigger a wave of competitive devaluations if times get much harder.
At a time when governments around the world are struggling to resist protectionism, the Swiss National Bank became the first central bank in the industrialised world to sell its currency as part of its fight against deflation.
The SNB presented the move as one of a series of measures it is using now that its rates have hit rock bottom, but it is not the only one to be grappling with this particular problem given the global economic downturn.
With interest rates in a race to the bottom around the world, others, such as Japan, are also looking for ways to help shore up their economies once they run out of monetary policy ammunition and could decide to follow the SNB's lead.
"The SNB have now fired the first formal shot in the forthcoming currency war," said Chris Turner, head of foreign exchange strategy at ING Financial Markets.
"Countries around the world faced with the zero bound constraint may now feel it is acceptable to formally intervene to weaken the currency to ease monetary conditions."
BEGGAR-THY-NEIGHBOUR
The most likely candidate to be tempted by the SNB strategy is seen by analysts as Japan, which in past decades has been the most active Group of Seven industrial nation in intervening to manage currency swings, both on the upside and on the downside.
"It remains to be seen if the SNB approach has pulled the lid off Pandora's box and will bring more into the devaluation game. Japan comes to mind," said David Gilmore, partner at FX Analytics in Connecticut in the United States.
There is a big difference between a country the size of Switzerland intervening to manage its currency swings and the world's second biggest economy doing the same thing.
Still, G7 finance officials in October 2008 effectively gave Tokyo the green light to intervene to weaken the yen, which was scaling 13-year high against the dollar -- an offer Japan may feel inclined to take up were the yen to revisit such highs.
The Bank of Japan has already slashed rates close to zero, is buying corporate bonds to ease funding strains, and is also grappling with a strong currency at a time when exports are slumping and the economy is sliding deeper into recession.
The Swiss franc rose about 10 percent in trade weighted
terms since July 2007, just before the financial crisis took a
sharp turn for the worse, to the end of January. The yen has
made even steeper gains, about 40 percent
CROSSING THE RUBICON
And where Japan leads, others in the region and elsewhere could follow, for example China.
"It goes without saying that the SNB's action increases the likelihood that other countries will also engage in intervention in order to improve their competitiveness," said Michael Klawitter, senior currency strategist at Dresdner Kleinwort in Frankfurt.
Major developed nations have taken great pains to avoid pursuing a beggar-thy-neighbour policy of currency depreciation, although eyebrows have been raised and pointed remarks made about a sharp slide in the British pound.
Switzerland may escape even such mild censure in public, not least since many analysts suspect it will have consulted central banks, notably the European Central Bank and the Federal Reserve, before acting.
Still, its decision to cross the rubicon by intervening in the currency markets may prove a tempting example for others to follow once options have run out and electoral pressures grow on policy makers to save jobs and protect key sectors.
"We shouldn't be surprised if central banks and governments do what they need to sort out their domestic problems," said Gavin Friend, market strategist at nabCapital in London. (Reporting by Swaha Pattanaik and Jamie McGeever; Editing by Victoria Main)