GBPCHF: A Tale Of Two Cities

by: Max Loh

A tale of two cities: one with an overly-weakened currency, and the other with an overly-strong one.

Both currencies trading at extremities have brought about undesired inflationary and deflationary pressures on each economy.

Long GBPCHF is a long-term play on the divergent needs and monetary policy paths of both the Bank of England and the Swiss National Bank.

A tale of two cities: one with an overly-weakened currency leading to rising inflation levels, and another with an overly-strong currency leading to depressed inflation levels.

The former describes the United Kingdom, a country plagued by negative media headlines detailing potentially painful consequences of a divorce with the European Union, leading to a sliding Sterling. The latter describes Switzerland, where the central bank has been relatively powerless as a strong franc threatens to cap inflation levels following their decision to de-peg the currency against the Euro.

Fundamentally, both the Bank of England and Swiss National Bank have divergent aspirations:

UK's benchmark interest rate is at an unprecedented low of 0.25%, while the country's Consumer Price Index (CPI) came in at elevated levels of 2.9% YoY this week, the highest amongst G10 nations. Although the Bank of England decided to keep the benchmark interest rate unchanged this week, its committee members spoke of the prospect of raising rates in the near future should inflation levels continue to climb.

To compound matters, traditionally dovish central banker, Gertjan Vlieghe, added more fuel to the rate-hike possibility by stating "data is increasingly suggesting that we are approaching the moment when [the] bank rate may need to rise.” This suggests the Bank of England may be preparing the markets for a rate hike this year, and more to come in the near future. A stronger Sterling is needed to temper inflationary pressures in the United Kingdom, and a low benchmark interest rate of 0.25% is surely unwelcome at this point.

To the east of the United Kingdom, the Swiss National Bank contemplates ways to encourage inflationary pressures to develop in the economy, certainly not helped by a strong Swiss Franc. A strong currency lowers prices of imports, which causes general price levels to remain depressed.

In 2015, the Swiss National Bank was forced to de-peg the franc from the Euro at 1.20, as the peg was difficult for them to enforce in the face of the relentless might of the European Central Bank's Quantitative Easing program. The European Central Bank wanted a weaker euro, the Swiss National Bank wanted a weaker franc - there was no way the latter could compete with the former's ammunition.

The Swiss National Bank held its interest rate meeting this week, where it kept its benchmark rate unchanged at -0.75%, while at the same time bemoaning the strength of the currency. The central bank acknowledged the recent weakness of the franc against the Euro, and stated: "[it] is helping to reduce, to some extent, the significant overvaluation of the [Swiss Franc]". The Swiss National Bank would welcome more weakness in their currency; with interest rates in negative territory already, it is difficult for them to affect currency weakness via monetary policy tools - all it can rely on are dovish soundbites with a dollop of hope.

This week has been crucial for both the GBP and CHF, and the divergent policies for both central banks have had their effects on the GBPCHF currency pair. As seen from the weekly chart below, GBPCHF has consolidated between 1.20 and 1.30 levels, and has closed the week at the higher bound of the range at 1.3070. Any break above this resistance level could spell more upside for the currency pair, with 1.40 the next resistance level.

Long-term investors or traders can play on this theme of two divergent economies, and look to buy GBPCHF should the currency pair break 1.31, with a stop loss at 1.28 and a take profit target at 1.40. The risk-reward makes sense, and this trade is backed up by both fundamentals and technicals.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.