By Gertrude Chavez-Dreyfuss
NEW YORK, July 7 (Reuters) - Investor appetite for the Swiss franc, a traditional safe haven, has swelled in recent weeks despite efforts by the Swiss National Bank to stem demand for the currency, fueling debate about the effectiveness of the central bank's strategy.
In March, the SNB surprised the market by buying euros and U.S. dollars and selling the franc as part of a slew of measures to avert deflation after interest rates hit rock bottom.
It was the first time that the SNB had intervened since 1995, and some believe it may have done more harm than good, as it could potentially damage capital flows and exacerbate deflation -- the opposite of intentions -- in that country by eroding the value of its assets.
"The SNB could be playing with fire," said Axel Merk, who manages the $350 million-Merk Hard Currency Fund in Palo Alto, California. "It's easy to destroy the currency, but it's difficult to regain that trust once you've lost it."
A weak currency typically leads to inflation because it prompts companies exporting to Switzerland to raise prices. A cheaper franc also makes Switzerland's exports more competitive in global trade.
But as the SNB intervened to weaken the franc, investors have snapped up the currency in the last few weeks, in effect daring the Swiss bank to chase them away, a battle central banks have lost in the past.
In the last week of June, UBS said clients exploited franc weakness to add to long positions in the Swiss currency. The net result was a week of heavy franc buying against the euro. Buying of the franc reached 11 percent of UBS volume, which by itself was 28.1 percent higher than normal.
UBS clients "took a more balanced approach" in the first week of July, with purchases of the franc accounting for about 0.4 percent of volume. Still, UBS currency strategist Gareth Berry said flows were brisk, with almost twice the normal levels as usual, "reflecting increased interest in the franc in response to intervention threats by the SNB."
"This has all the imprints of private speculators in the market," said Michael Woolfolk, senior currency strategist at Bank of New York Mellon in New York.
THE LINE IN THE SAND
Many in the market believe the SNB was trying to prevent the euro from falling below 1.50 francs, a view denied by SNB board member Thomas Jordan last week. "We do not do this (intervening) at a particular level but we decide on an ad-hoc basis to achieve a large impact," Jordan said.
The euro zone is an important market for Switzerland, accounting for about 65 percent of total Swiss exports and 78 percent of imports.
Those betting against the franc are trying to get the SNB to defend a rate below 1.50 -- a trade that calls for selling the euro against the Swiss franc -- to the point where the central bank elects not to print money and devalue their currency in an effort to maintain a line in the sand.
After the SNB intervention in March, the euro rose to more
than 1.50 and has remained there since
If the SNB lets go of 1.50, analysts believe the pair would set a new threshold at around 1.45.
But traders challenging the SNB could end up squeezed if the intervention is successful. The Swiss central bank has been accumulating reserves as a result of the safe-haven flight during the financial crisis and may continue to do so by printing its currency to sell against the euro and the dollar to avoid strengthening the franc.
Total SNB reserves excluding gold were at $51.5 billion at the end of May, highest since March 2003, representing an increase of nearly 16 percent since August 2008, just before the global crisis erupted.
The SNB has denied that they intervened to weaken the currency - instead acting to stop it from rising, and officials have said this has had the desired effect. Swiss monetary authorities have sold the franc several times after the March announcement, with more aggressive forays the last days of June. As a result, the Swiss franc has fallen 4 percent versus the euro since March.
But traders said the Swiss intervention's shock value seems to have faded. The euro is just roughly 1.0 percent above 1.50 francs limit and many in the market believe the SNB will intervene again.
MINOR SWISS INDEX FALL
The franc's decline also seems paltry when based on the Bank of England's trade-weighted index of the Swiss franc, an indicator which the SNB tracks as well. The Swiss trade index has fallen about 1.5 percent since March, traders said.
"We're talking about a less-than-two-percent move in the Swiss trade-weighted index, which to me doesn't seem to be a huge deal," said Marc Chandler, global head of FX strategy at Brown Brothers Harriman in New York."
Chandler said the need to weaken the franc to combat deflation was questionable in the first place. Unlike the United States, Switzerland has a current account surplus of 11 billion francs -- meaning it lends out more than it borrows -- and therefore does not need to push its currency lower to stimulate export demand in the way the U.S. does.
(Additional reporting by Sven Egenter in Zurich)