The SNB’s Forward-Looking Compromise
Building the case for more FX intervention
Related posts (with links):
Switzerland August-24 CPI Inflation Report (August inflation release);
Switzerland July-24 CPI Inflation Report (July inflation release);
The SNB’s challenging rebalancing act (related post);
The SNB sets the time (related post);
The SNB operational framework: a Primer (teaching note)
In its September 2024 monetary policy meeting, the Swiss National Bank (SNB) cut its policy rate by 25 basis points, reducing it from 1.25% to 1.00% - the third cut this year. This decision was in line with market consensus expectations, although financial markets had priced in a non-negligible probability of a 50-basis-point cut.
Key takeaways:
The significant revision in the conditional inflation forecast was accompanied by the indication of possible further rate cuts (forward-looking shift).
The appreciation of the Swiss franc is an open concern:
Looking ahead, a less aggressive easing cycle than what is currently priced in the market for the Federal Reserve might limit the appreciation of the Swiss franc against the US dollar.
Conversely, a deterioration of the economic outlook in the Euro-are and a sustained easing cycle by the ECB could prompt further appreciation of the Swiss franc against the Euro.
Balance Sheet policies will be the norm for the SNB: We should expect more foreign exchange rate intervention from the SNB as interest rate policy has proven to be less effective in mitigating the strength of the Swiss franc.
The Monetary Policy Assessment
The most surprising element of the SNB’s monetary policy assessment was the significant revision in the conditional inflation forecast compared to previous meetings (see figure above). For 2025, inflation is now projected to be around 0.5-0.6% annually (rather than ~1.0%), even after considering the current rate cut.
Although this inflation forecast remains within the SNB’s target range of 0% to 2%, and in line with their definition of price stability, the sharp adjustment from prior forecasts raises the question of why a 50-basis-point cut was not implemented.
The possible interpretation that I put forward suggests that the SNB has taken a more explicit approach in signaling that further rate cuts are likely (Chairman Jordan in the press conference stated [freely translated] “Further cuts in the SNB policy rate may become necessary in the coming quarters to ensure price stability over the medium term”). The SNB did not fully do it yesterday (25bps cut instead of 50bps) but signaled that it could do it in the near future. I refer to this middle ground as a forward-looking compromise. It is a compromise because, as I will discuss later, by not cutting rates as much yesterday, the SNB will most likely require a more aggressive foreign exchange intervention to avoid even further Swiss franc appreciation.
Let’s compare two key passages from the June and September policy statements. In June (as well as in March 2024), the SNB stated:
“The SNB will continue to closely monitor the development of inflation and will adjust its monetary policy if necessary to ensure inflation remains within the range consistent with price stability over the medium term.”
In September, this language shifted to:
“The SNB’s easing of monetary policy today reflects a reduction in inflationary pressures. Further cuts in the SNB policy rate may become necessary in the coming quarters to ensure price stability over the medium term.”
In my view, this change introduces a forward-looking element to monetary policy that was absent in the most recent statements when the SNB lowered rates.
Most of the policy assessment and also the press conference had focused on interest rates, inflation and the Swiss franc, but it is worth examining how all this play out in terms of the growth outlook. Interestingly, the growth outlook has not changed at all (at least at first pass).
In June 2024 the SNB stated:
“Growth is likely to remain moderate in Switzerland in the coming quarters. The SNB anticipates GDP growth of around 1% this year. In this environment, unemployment is likely to continue to rise slightly, and the utilisation of production capacity is set to decline slightly. Over the medium term, economic activity should improve gradually, supported by somewhat stronger demand from abroad. The SNB currently expects growth of around 1.5% for 2025”.
In September 2024, the corresponding paragraph was expanded to acknowledge the possible role of the exchange rate but overall there is no change in the GDP growth forecast.
“Growth is likely to remain rather modest in Switzerland in the coming quarters due to the recent appreciation of the Swiss franc and the moderate development of the global economy. The SNB anticipates GDP growth of around 1% this year. In this environment, unemployment should continue to rise slightly, while the utilisation of production capacity is likely to decline slightly. Over the medium term, the growth-dampening effect of the recent appreciation should subside and economic development should gradually improve as a result. The SNB currently expects growth of around 1.5% for 2025”.
In other words, no short and medium-run implications on aggregate GDP growth, but probably with sectoral divergences between services and manufacturing.
Background
The September 2024 monetary policy assessment clearly highlights the role of the Swiss franc as a key factor in shaping inflationary dynamics. The SNB stated:
“Inflationary pressure in Switzerland has again decreased significantly compared to the previous quarter. Among other things, this decrease reflects the appreciation of the Swiss franc over the last three months.”
Additionally, the SNB noted that:
“The stronger Swiss franc, along with a lower oil price and electricity price cuts announced for next January, has contributed to the downward revision.”
Given these considerations, let’s briefly review the inflation outlook leading up to the SNB’s policy decision.
As noted in previous posts (such as our monthly CPI reports – the latest being August’s and July’s), there exists a dichotomy in Switzerland’s inflation dynamics. Inflation is largely domestically generated (see “The SNB’s challenging rebalancing act”), driven primarily by the housing rental component. When we exclude this component from the index, inflation stands at just 0.4% year-on-year, as shown in the figure above. Additionally, the appreciation of the Swiss franc has played a crucial role in driving import price deflation.
Within this context, another notable aspect of the recent policy decision is that, despite two consecutive 25-basis-point cuts, the exchange rate has shown no signs of depreciation. On the contrary, the Swiss franc has continued to appreciate throughout the easing cycle. This is evident in the following plot of the Real Exchange Rate Index, which highlights the franc's persistent strength.
The next two figures provide a more familiar account of these patterns by looking at the CHF/EUR and CHF/USD bilateral exchange rates.
At first glance, the interest rate differential provides a good guide in terms of exchange rate direction. However, considering recent policy shifts in other advanced countries, the SNB’s primary policy tool — the interest rate on sight deposits — has not been effective in mitigating the appreciating pressures on the Swiss franc. Despite the easing measures, the Swiss franc has continued to appreciate.
In my previous commentary (link here) I concluded by listing the SNB’s challenges:
· Cutting interest rates might not be sufficient and the SNB might be forced to intervene more actively in the foreign exchange market expanding its balance sheet.
· Political uncertainties on both sides of the Atlantic as we enter the second half of 2025 could further strengthen the Swiss franc. Consequently, more interest rate cuts and foreign exchange interventions cannot be ruled out.
· There is a risk of reverting to a pre-Covid environment characterized by low interest rates and deflationary pressures.
The Risk of the Forward-Looking Compromise
The decision to cut by 25 basis points and not by 50 basis points, despite the significant reduction in the conditional inflation forecast, reflects a cautious approach. This allows the SNB to preserve policy space and closely monitor developments until December 2024.
In what follows, I shortly outline the potential risks and implications of this strategy.
The main risks come from external factors:
· Foreign monetary policies: The Federal Reserve has already aggressively embarked on its easing cycle, and rising unemployment may prompt further cuts in the U.S. Market pricing might be more aggressive than what might eventually materialize, which could in principle limit Swiss franc appreciation vis-à-vis the USD. On the other hand, the European Central Bank (ECB) has been more cautious in its actions and intentions, but deteriorating economic conditions in the core of Europe could push the ECB into a more sustained easing cycle, which would increase the appreciation pressure on the Swiss franc.
· Geopolitical tensions and political uncertainty: Geopolitical tensions in the Middle East and the Ukraine/Russia conflict could further impact global markets and economic stability. Similarly political uncertainty surrounding the upcoming U.S. elections adds another layer of instability to global markets and widens the band around economic forecasts. Switzerland, as a safe haven currency country, could see these factors further fuel the franc’s appreciation.
These aspects may lead to additional deflationary pressures, particularly on imports and goods prices. With rent-driven inflation expected to ease in the second half of 2025, Switzerland could face a deflationary environment resembling the pre-COVID period.
As a result, the SNB may need to take more active steps, such as intervening (once again) in the foreign exchange market during the last quarter of the year. With the release of official SNB data on foreign currency intervention due by the end of this month, we will see if the SNB has already actively bought foreign securities in the third quarter, as they did in the second quarter.
Add-on from the press conference
Two additional interesting points from the press conference are worth noting. First, from a monetary policy perspective, questions related to a 50bps cut were raised a couple of times, with Jordan being asked the extent to which that was one of the options. Chairman Jordan implicitly suggested that it was the other option:
“we were focused on determining, against the backdrop of the changes in the inflation outlook, what monetary policy adjustments would make the most sense. The decision you saw was to make a 25-basis point cut, and we made it very clear that further rate cuts might be necessary to maintain inflation within the range of price stability” [freely translated by me]
Second, one reporter asked about r*– probably with the idea of getting some sense of what the level of neutral interest rate is for Switzerland –, but there was no specific reply from Jordan.
Conclusions
To conclude, while the SNB's current interest rate policy is expected to be effective in keeping inflation within its target range in the medium term, external factors could lead to a further strengthening of the Swiss franc, thereby increasing deflationary risks and tipping the balance towards a return to the pre-Covid environment of very low interest rates and balance sheet expansion in Switzerland.