Here’s why the Aussie dollar is refusing to fall. The interim report of the Swiss National Bank would normally not be the place to look for an explanation of why the dollar has been very strong for much of 2012. But that’s where a major part of the can be found, especially why we have soared against the euro.

It’s all to do with the SNB’s decision last September to support the value of the franc at 1.20 to the euro. To do that (and support Swiss exporters, which include big drug and manufacturing companies, as well as banks and insurers) the central bank has solid bought tens of billions of francs and bought euros.

It has to try and balance its surging reserves by selling the recently bought euros and buying other currencies such as the Australian dollar this year, especially in May and June when the eurozone again trembled. The aggressive Swiss buying of the Aussie dollar has coincided with reports of buying by other central banks and supranational organisations (such as the various development and investment banks, attracted by Australia’s high yields and especially the AAA rating.

Central banks in China, Russia and South Korea have been reported as either buying Australian dollar assets or are planning to diversify their reserves away from the US dollar and the euro. This support helps explain why the currency has held up despite the noticeable worsening in our trade performance and the drop in our terms of trade.

The Aussie dollar hit a low of just over 95 US cents in May, but this morning traded at well over $US1.05, a gain of 10.5%. The Financial Times points out the detail in the Swiss central bank’s report helps explain “some Aussie dollar stickiness” (how it is holding its value against other currencies) in recent weeks. It in particular explains how the Aussie dollar has managed to make gains against the euro, reaching a succession of new highs in the past month. The SNB has been selling euros to buy Australian dollars, plus the currencies of Denmark, Sweden, Norway , Singapore and South Korea.

The Swiss National Bank only decided last September to defend the value of the franc and try and keep it “cheap”. It set a value of 1.20 francs to the euro and started selling francs and buying euros. But in May and June the bank was forced to step up its purchases of euros and billions of dollars of worried money flowed into the country as the eurozone wobbled (yet again) and the euro fell sharply.

The half-year report shows that Switzerland has 365 billion Swiss francs (about $US374 billion or $A356 billion) worth of foreign exchange. That’s up 40% so far this year and the country now has the sixth biggest reserves in the world behind China, Japan, Saudi Arabia, Russia and Taiwan. That’s a rise of 107 billion Swiss francs, or about $A110 billion, which is a huge increase by any measure. Some of that has gone into buying the Aussie dollar.

But in defending the franc rate of 1.20, the SNB has been accumulating more euros than it can handle. As a result it has been unable to sell them fast enough. At the end of June, the proportion of its reserves held in euros has risen from 51% at the end of the first quarter to 60% by June 30. The proportion held by the US dollar has fallen from 28% to 22%, the yen is down to 8% from 9%, the UK pound is down to 3% from 5% and the Canadian dollar eased to 3% from 4%.

The report shows that the bank has invested more than 36 billion francs in other currencies ($A37 billion) since September 1 last year, with 12.4 billion of that in the June quarter, up more than 50% from the 8.05 billion bought in the March quarter. That is a significant amount of money by any measure (Australia’s foreign reserves total $A49 billion).

With buying by other so-called official sources (central banks), it’s no wonder the Aussie dollar has been able to hold its value, despite a fall in the value of our exports, the drop in the price of iron ore (our most important export, especially in the last month), the fall in the value of coal exports and the overall 10%-plus fall in our terms of trade since last September. Helping this has been the sharp fall in the amount of AAA-rated securities around the world (from $US10 trillion to $US3 trillion), which means central banks have a smaller pool of eligible currencies and assets to buy.

The Aussie dollar is now just under the level it was at the start of September last year when it traded well above $US1.05, and then fell under $US1 and climbed back over. But it is up more than 13% against the euro in the same time, from just over 75 euro cents to more than 85 euro cents. For that we can blame the buying by the Swiss National Bank in particular. That helps explain why the fall in interest rates of 1.25% since last November has had no impact on the currency’s value and why calls for the Reserve Bank to cut again next week to reduce the upward pressure on the currency, will have little or no impact.

In some respects the day-to-day value of the dollar is out of our hands. This rebalancing will continue for as long as the euro crisis continues and investors want somewhere safe to keep their money, such as Switzerland. But if the SNB can’t offload its surplus euros in a steady fashion, it might be forced to sell them more quickly, a move that would drive the euro lower and inject a surge of volatility into currencies like the Aussie dollar.

Peter Fray

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