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Having effectively brought inflation back to within its target range since July 2023, the Swiss National Bank scans as the most likely candidate to kickstart the DM easing cycle.
Up until recently, we believed this would be the case and forecast a rate cut of 25bps in Q1, bringing the policy rate to 1.5%. Our view was based on the perceived concern at the SNB over the strength of the franc at a time when domestic inflation and growth conditions were benign, and the external environment had turned less inflationary. This view was corroborated by the December statement, where the SNB removed its explicit bias for a stronger franc, and intermeeting communications in January that confirmed this was motivated by the deflation risk a stronger CHF posed. Since President Jordan’s comments to this effect in January, the depreciation in the franc, both in nominal and real terms, and the renewed concern over inflation persistence in key trading partners have reduced the pressure on the SNB to act.
In addition to data showing the Swiss economy grew at a faster-than-expected pace in Q4 and inflation momentum improving in February, we now think the SNB will delay any decision to cut until June. However, risks of a cut this week remain. Should the SNB deem the balance of risks to the trade-weighted CHF as tilted towards further appreciation in Q2, policymakers may opt to cut rates before the ECB and Fed to avoid using their balance sheet to offset any future appreciation pressures.
Under our base case for the SNB to remain on hold until June and the ECB cutting only once next quarter, we expect EURCHF to trade in the range of 0.96-0.98 in Q2, with the level of the currency dependent on the strength of domestic inflation pressures and eurozone growth conditions. In our risk case where the SNB cuts on Thursday, we think EURCHF could rise to parity as early as Q3, contingent on a higher for longer ECB stance and renewed weakness in Swiss inflation pressures as the tourism season ends.
Domestic and external developments in recent weeks have reduced the need to cut
In recent weeks, the urgency for the SNB to cut rates has moderated considerably due to domestic and external considerations. This has led the implied probability of a cut to fall from 75% a month ago to just 27.5%. On the domestic front, growth and inflation data have eased concerns that monetary policy is overly restrictive. Following a surprise drop in headline inflation to just 1.3% YoY in January, despite start of the year tax hikes suggesting otherwise, the pace of disinflation in February slowed as headline CPI fell to just 1.2%.
While this still leaves the metric on track to considerably undershoot the SNB’s Q1 forecast of 1.8% and is likely enough of a forecast miss for the central bank to downgrade its full-year inflation forecasts further below the 2% ceiling, the details of February’s report suggested the outright deflation risk remained minimal. If anything, they now point towards renewed inflation momentum.
After flatlining since the beginning of Q3, the 3-month annualised measure of headline inflation jumped in February, rising to 3.5%. Similarly, inflation once excluding fresh and seasonal products, energy and fuels, a measure closely watched by the SNB, also accelerated to 2.3% on a 3-month annualised basis in February. Most concerningly for the SNB, however, this uptick in price pressures appears domestically driven, even as imported inflation continues to be a drag on headline inflation readings. 3-month annualised private services inflation rose to 7.1% in February, dragging domestic inflation as a whole to 6.1% on the same basis, a notable rise after both readings had previously stabilised at levels consistent with the SNB’s inflation target in the second half of last year.
Recent acceleration in underlying inflation suggest the SNB should be more cautious in cutting rates
Against this more inflationary backdrop, it is significant that Q4’s GDP data surprised to the upside, printing at 0.3% QoQ, suggesting inflation momentum could well be sustained. The SNB indicated in December that the Swiss economy is operating slightly above potential output, accompanied with a suggestion that moderate growth of 0.5-1% in 2024 was needed to see a decline in overall capacity utilisation. Since then, the economy posted a 0.3% expansion in Q4, with the single largest rise in output concentrated in the wage sensitive accommodation and food services sector (+3.5%).
Admittedly, this was in part down to a recovery in tourism. But alongside a broader expansion in services activity, including the similarly wage intensive health and social care services (+1.4%), we think there is a potential upside risk to the inflation outlook, stemming from domestic services demand.
These upside inflation risks look unlikely to fade as well with the economy projected to grow by a further 0.3% in Q1 according to consensus forecasts or 0.4% when looking at the KOF Institute nowcast. Looking further out tells a similar story. A survey of economists by Bloomberg suggested that the Swiss economy will expand 1.2% in 2024, 1.5% in 2025 and 1.6% in 2026, which if the SNB is to be believed, is not a pace that would allow inflation pressures to cool back to target.
External factors also suggest that a more cautious approach may be warranted by the SNB. Chief amongst these is the EURCHF rate.
While the SNB utilised the franc to supplement its monetary tightening cycle throughout 2023, the removal of its bias towards further franc appreciation and subsequently dovish commentary aimed at weakening the currency has seen EURCHF rally over a 1% since December’s meeting, and climb over 3% this year. At 0.96, we think the prevailing EURCHF rate provides a relatively neutral inflation impact on the economy, rendering the SNB’s restrictive stance contingent on just policy rates. A similar argument can also be made for the USDCHF rate, which is up 5% year-to-date. From here, we think further CHF depreciation raises the risk of renewed import inflation at a time when the domestic inflation pressures are mounting.
With both the Fed and the ECB now not expected to loosen policy until late Q2 as concerns globally turn towards inflation persistence, a rate cut from the SNB risks an untimely sharp sell-off in the currency on widening rate differentials.
But a rate cut can’t be completely ruled out
While recent data outturns and the performance of the Swiss franc have dramatically reduced the probability of an SNB cut this week, such action can’t be completely ruled out. Should policymakers view the risks of renewed franc appreciation as too high, there is a chance that they will cut rates to avoid intervening in FX markets to weaken the franc over the course of Q2. Not only have previous periods of FX purchases proven politically sensitive after the franc appreciated and resulted in the SNB recording operational losses, but FX intervention to depreciate the domestic currency is also less effective in periods where the monetary stance is restrictive. Unlike in 2020-2021 when the SNB intervened aggressively to weaken the franc, interest rates are now positive, meaning FX purchases must be sterilised to avoid expanding the monetary base and fuelling inflation.
With sterilised intervention estimated to be less effective, and the SNB’s latest efforts to weaken the currency proving to be politically sensitive, we think policymakers would lean towards a pre-emptive cut in policy should they deem the risk of renewed CHF appreciation and/or imported deflation as elevated.
Authors:
Simon Harvey, Head of FX Analysis
Nick Rees, FX Market Analyst