UPDATE 1-Swiss franc rise would pose big economic risk -SNB

Mon Sep 3, 2012 2:53pm IST

* SNB's Jordan says bank determined to enforce franc cap

* PMI data points to gloom among manufacturers

* Aug sight deposits suggest less spent on interventions

* Swiss Q2 GDP data due on Tues, CPI on Weds

* SNB still worried about real estate prices (Adds data, economist comment, background)

By Catherine Bosley and Emma Thomasson

ZURICH, Sept 3 (Reuters) - The Swiss central bank is determined to defend its currency cap as a rise in the franc would pose a major threat to the economy, the bank's head said on Monday, as data showed the country's manufacturing sector contracted more sharply in August.

The bank set a cap of 1.20 per euro on the franc almost exactly a year ago, citing a risk of deflation and a recession as investors seeking sanctuary from the euro zone crisis pushed the Swiss currency up sharply.

"In the current situation, a further appreciation of the Swiss franc would constitute a very substantial threat to the Swiss economy, and would carry with it the risk of deflationary developments," Swiss National Bank Chairman Thomas Jordan said in a speech.

"With this in mind, we will continue to enforce the minimum exchange rate with the utmost determination, in line with our mandate."

Monday's purchasing managers' index reading supported Jordan's warning, showing a manufacturing slump deepened last month, contrasting with a more upbeat outlook from the leading KOF indicator last week.

"The SNB has no reason to change its policy," said Julius Baer economist Janwillem Acket.

The PMI index fell to a seasonally adjusted 46.7 points from 48.6 points in July. The print, missing analysts' forecasts for 49 points, was the fifth in a row below the 50 point mark that separates growth from contraction.

"In view of the roller-coaster ride in Europe, Swiss industry is failing to pick up," said index compilers Credit Suisse and the SVME purchasing managers' association.

"The creeping downturn in industrial activity should therefore continue in the months to come, especially since the backlog of orders is continuing to trend downwards."

FOREX RESERVES BALLOON

Analysts tend to watch Swiss economic data closely to see if it continues to support the case for the cap, which the SNB is having to defend with heavy interventions. Its foreign currency reserves hit nearly 70 percent of gross domestic product in July.

The amount of cash commercial banks hold with the SNB rose to a new high last week, figures showed on Monday, but the pace of the increase slowed, suggesting the central bank did not intervene as much last month as in July.

Asked in an electronic poll if they thought the SNB could sustain the cap, 66 percent of the participants at the financial conference where Jordan was speaking said "yes".

Figures showing how much the SNB's foreign exchange reserves increased in August are due out later in the week, while data on second-quarter GDP growth is due on Tuesday and August consumer prices are out on Wednesday.

"It is too early to talk of an all-clear. The economy has probably lost significant dynamism in the second quarter already," said Bernd Hartmann, head of investment research at VP Bank. "A renewed escalation of the (euro) debt crisis would also have serious consequences for the Swiss economy."

Julius Baer economist Acket said the main reason for the discrepancy between the PMI survey and the more upbeat KOF indicator was that the former reflected sentiment at hard-hit small and medium-sized manufacturers.

"We are in a kind of split economy, with the metalworking, machinery and investment goods industry suffering from the European contagion, while services - and even tourism - are not doing so badly despite the high exchange rate," he said.

In his speech, Jordan reiterated concern about strong rises in Swiss real estate prices in recent years, partly fuelled by the low interest rates the SNB has been forced to maintain to stop the franc from soaring.

"The risk of a further build-up of imbalances followed by a significant price correction is still present," he said.

In July, new rules to constrain risky lending by banks were enacted. Yet due to signs of a cooling of the property market, the SNB has decided for now to forego forcing banks to boost their capital via a buffer. (Reporting by Catherine Bosley; Editing by Andrew Heavens, John Stonestreet)

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