Hints of FX intervention as central banks debate Brexit response

By Patrick Graham and Anirban Nag

LONDON (Reuters) – Warnings from officials in Japan and Switzerland on Thursday left financial markets wondering about what central banks are planning behind the scenes if Britain votes to leave the European Union next week.

It is five years since major monetary authorities waded in to currency markets in a concerted push to quell gains for the yen after a shattering earthquake in Japan.

Such coordinated action in the era of floating exchange rates is rare, and central banks have so far restricted themselves to promises to provide any funding banks might need in the event of a stormy aftermath to next Thursday’s referendum.

Officials told Reuters earlier this week the European Central Bank would pledge to backstop markets in tandem with the Bank of England after a vote to leave.

But a raft of official policy statements following four major central bank meetings this week — and amid evidence that momentum within the British electorate is shifting towards the Brexit camp — offered hints that policymakers are considering whether they will need to do more.

“Sharp fluctuations could occur in the FX market, with the pound depreciating massively amid low liquidity. This could prompt the central banks of the developed countries to conduct joint FX market interventions,” said Antje Praefcke, a currency strategist at Commerzbank in Frankfurt.

The Swiss National Bank said outright it would be active on the franc and would take steps to counter any Brexit fallout. Chairman Thomas Jordan added central banks were holding intense exchanges on market developments.

“We have a global view, we follow markets on a 24-hour basis,” SNB governing board member Andrea Maechler said.

The Bank of Japan, the subject of intense speculation since January over possible intervention against the yen, refrained from offering additional monetary stimulus on Thursday.

That sent the yen, a safe-haven during times of financial market stress, to a two-year high, up three percent against sterling.

Government spokesman Yoshihide Suga expressed concern about the yen’s rise and said Japan would respond if needed.

“The SNB and potentially the Bank of Japan would want to intervene and drive down the value of their currencies,” said Yujiro Goto, a currency strategist at Nomura in London.

“It is pretty clear, especially with the SNB… that currency intervention will be the first line of defense for them.”

FRANC LESSONS

Leading figures on the foreign exchange market are nervous that a “Leave” vote might spawn the kind of gaps in currency market pricing that provoked chaos when the SNB lifted its cap on the franc in January 2015.

Traders and analysts say liquidity conditions during Asian trade, when the referendum results will start to trickle in, are likely to be thin and bid/offer spreads are likely to widen.

Some say they have told the Bank of England that if there are large gaps it should be prepared to intervene steadily to prevent huge swings in the market as banks and investors seek to establish a new price for sterling.

In the case of the franc, the overshooting of rates played a role in bankrupting some retail brokerages and dozens of their clients, while major banks and hedge funds faced hundreds of millions in losses.

Strategists in London are loath to discuss the issue of intervention publicly but many have predicted double-digit falls in sterling if Britain votes to leave.

The main objective of interventions “would be to dampen excessive near-term fluctuations and prevent things from getting worse,” Commerzbank’s Praefcke said.

The mechanics would involve the swap lines banks opened up to each other to ensure currencies were available amid vanishing liquidity during the global financial crises of 2008.

At that point, the Reserve Bank of Australia intervened in New York as well as Sydney to provide Australian dollar liquidity after bid/offer spreads widened, making trading close to impossible.

The RBA was clear then that it was intervening not with any level in mind but to smooth out liquidity conditions.

“”There are some examples in the past when central banks have intervened in volatile markets,” said HSBC strategist Dominic Bunning. “Obviously we are considering what may or may not happen.”

(Writing by Patrick Graham; editing by John Stonestreet)