The Swiss National Bank will have to wait years before it can start winding down its huge foreign currency holdings for fear of triggering renewed rises in the Swiss franc that would hurt exporters. Before it can safely start selling those reserves, it will first have to ensure the export-driven Swiss economy is on a sound footing, putting the SNB at the back of the queue as other central banks start withdrawing their easy-money policies.
As monetary policy at the European Central Bank and US Federal Reserve edges towards normalisation, markets have started pondering what will become of the SNB's huge foreign currency holdings. Its foreign cash pile has become the world's largest in relation to GDP, representing nearly 120 percent of Switzerland's economic output. The ratio dwarfs the holdings built up by the Fed, the Bank of Japan and the ECB and has triggered concerns about losses the SNB could rack up as currency swings bite.
This could fuel political pressure from the federal and cantonal governments that get SNB profit payouts. Still, the SNB is unlikely to be able to reduce for several years its balance sheet, which has soared seven-fold in a decade to reach 775 billion Swiss francs ($800 billion). Foreign reserves - mainly currency, bonds and equities - make up the bulk of the holdings it has accumulated to weaken the franc and protect Switzerland's export-reliant economy.
The central bank, which declined to comment, is unlikely to sell off its gold holdings, while its Swiss franc investments make up only a tiny proportion of the total. If the SNB started to sell off foreign bonds and equities, it faces a problem as the bank converts the proceeds into francs before cancelling them.
"Shrinking the balance sheet is just not possible. To do that they would have to buy back francs, which increases the value of the franc again and is exactly what the SNB wants to avoid," said Thomas Stucki, a St Galler Kantonalbank analyst who used to manage SNB currency reserves.
Although the euro has gained 6 percent against the franc in the last six months as fears over the break up of the euro receded, the franc could strengthen quickly on renewed geopolitical risks like tension in the Korean peninsula. Asset sales would be spotted immediately when the bank releases details of its foreign-currency reserves, potentially triggering a new rush into the currency.
"When the other (central banks) start reducing their balance sheets, that will be the opportunity for the SNB to do likewise. But if it simply goes ahead the franc will become too strong and we have a problem again for our exporters," said Thomas Aeschi, a member of parliament's finance and economics committee.
Many analysts think the SNB will hold fire until the European Central Bank starts tightening its expansive monetary policy. Higher euro zone interest rates reduce the allure of the safe-haven franc. But the SNB has surprised markets in the past, as when it suddenly abandoned its 1.20 floor for the franc against the euro in January 2015, and may not provide any clues before it starts normalising policy.
An improving Swiss economy and exports could give the SNB room for manoeuvre and start raising rates on its own. If Swiss asset managers resume investing in the euro zone rather than repatriating money into francs, that would also be a positive signal. This long-term trend, more than recent franc weakness versus the euro, could reassure the SNB it is safe to start unwinding its investments.
Even if the franc - now trading around 1.1350 to the euro - fell again to 1.20 the central bank would no doubt remain ultra cautious when uncoiling its holdings. "The SNB is stuck between a rock and hard place," said SGKB's Stucki. "They may be able to trim a few billion here and there from the balance sheet, but in the next few years at least they are going to have to live with it."