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Switzerland reports its October consumer prices on Monday. This could be important. The Swiss National Bank's decision to cap the franc took place on the same day that the August CPI was reported (September 6). It showed a 0.3% month-over-month decline after a 0.8% decline in July. There are many observers who expect the Swiss National Bank (SNB) to lower its cap for the franc (that is, raise the euro floor from CHF1.20 to CHF1.25 or higher) and see the risk of deflation as a potential trigger.

The Bloomberg consensus is for a 0.2% month-over-month rise in October after September's 0.3% increase. That September increase was the first increase in four months. However, the year-over-year rate is expected to slip toward 0.2% from 0.5%, suggesting that the risks of deflation have increased. Due to base effects, the year-over-year rate is likely to be zero or below in this month's report, before stabilizing in December and January '12. New weakness is likely toward the end of Q1'12.

The Swiss economy is weak, as reflected broadly in the 46.9 PMI reading (from 48.6 in September). Retail sales are off almost 1% from a year ago (-.0.9% in September) and the KOF leading economic indicator fell to 0.8 in October, its lowest level since September 2009.

Monetary policy is already bounded by zero. The SNB's attempt to cap the franc, thus far successful, should be understood not just in a mercantilist context to promote exports (real exports rose 3.4% in September and 1.3% from a year ago), but also as another form of quantitative easing.

When queried recently, the SNB's Danthine explained that the central bank chose CHF1.20 instead of CHF1.25 because it better reflected the balance of risks (economic) and credibility in the market. The SNB's success has arguably boosted its credibility. Its reserve position is complicated and difficult to understand. In the October figures released earlier Friday, reserves fell to CHF242.7 billion from CHF282.2 billion in September. This appears to be be because of unwinding of positions in the swaps and forwards market. (Take note Bank of Japan, the SNB did not just intervene in the spot market.) In any event, it does not look as if the SNB was forced to spend very much money to achieve its goal.

The risk that the SNB lowers its ceiling for the franc cannot be ruled out, any more than QE3 can be in the U.S. Given the turmoil in Europe, the still lack of resolution of the debt crisis, and perhaps even its intensification (see Italy), the SNB may not want to alter its tactics and risk jeopardizing the success it has already achieved; not only weakening the franc by around 20%, but taking it largely out of play.

Disclosure: No positions