The strength of the Swiss Franc is weighing on efforts by policymakers to keep prices stable.
CNBC reported that the Swiss National Bank is increasingly under pressure as the Swiss Franc nears record levels. This could lead to an economic slowdown and a decline in consumption, especially for the nation which relies heavily on exports.
The SNB cut interest rates for the third time this year in September. It attributed the decline in inflation to the continued strength of the Swiss franc, as well as lower energy and electricity prices.
Bank of America revised its inflation estimate for 2024 down to 1,2%, and then further down to 0,6% by 2025. This is a significant change from the previous forecast of 1,1%.
Thomas Jordan, outgoing SNB chairman, admitted the effect of the strong Franc, but downplayed the deflation risk, saying that inflation was “within ranges of price stability.”
Jordan did add that policymakers are ready to adapt their strategy to stabilize inflation, if needed.
Deflationary pressures may lead to currency intervention
Analysts predict that despite the SNB’s rate reductions, Switzerland’s continued appreciation of the franc could force Switzerland’s central bank to turn to FX intervention in order to curb inflation if conventional policy tools are not enough.
Adrian Prettejohn is the Europe economist for Capital Economics.
The SNB could cut interest rates further, but because the franc’s appreciation can push Switzerland to deflation, the SNB should intervene directly in the FX market to influence the currency value.
A central bank can buy or sell its own currency on the market in order to affect its rate of exchange relative to other currencies.
This could be a way to manage inflation in countries that are heavily dependent on trade, such as Switzerland, and where imports account for the majority of prices at retail.
Sophie Altermatt, an economist at Julius Baer, echoed Prettejohn, saying FX interventions could be necessary if the sharp appreciation of the franc continues.
Swiss inflation drops as the franc rises
Investors’ demand for safe haven assets in the face of global volatility, and the demise of carry trades on the yen has boosted the appeal of the franc.
The EUR/CHF rate and the USD/CHF rate have both reached historic highs, with EUR/CHF at 0.9414, and USD/CHF at 0.8669.
Switzerland’s Inflation has meanwhile continued to decline.
The SNB was the first Western central banks to reduce rates in March when inflation reached 1.2%.
The rate of inflation has dropped to 0.8% from 1.1%, in September.
Capital Economics has recently reduced its inflation projection, predicting that it will fall from 0.8% to 0.3% in 2025.
Prettejohn added that “deflation” is now “a real possibility.” “Our projection is that inflation will fall to as little as 0.1% for some months. It wouldn’t take much, then, to get that number below zero.”
Perspectives for future policy changes
SNB Chairman Thomas Jordan said last month currency intervention is still an option. However, he did not commit to a timeframe.
A Reuters survey shows that economists believe the SNB will keep its rates unchanged at the next meeting, in December, before reducing them by 25 basis points early in 2025. This could bring the final rate down to 0.75%.
Analysts believe that the SNB may look to FX markets in order to find further relief.
UBS’s economist Maxime Botteron said that, “once policy rates are exhausted,” the bank may turn to currency interventions.
BNP Paribas noted in a note that “FX interventions may be a better policy tool, as the SNB policy rate approaches its lower effective bound,” highlighting the limits of conventional monetary policy.
Risks and intervention options for the franc
Botteron says that while currency interventions could provide temporary relief, Botteron does not believe the Swiss Franc’s strength is a reason for alarm.
He said that “we are not at a point where [the] Swiss Franc is overvalued,” and pointed out that its rate of appreciation remains below the previous highs seen in 2011.
Botteron said, “We do see some downside risks to inflation in the coming year.” As long as there is no sharp increase in the value of our currency, I believe that a deflation risk that would require a more aggressive ease of monetary policies… at this point is unlikely.
Analysts remain cautious despite these assurances. They note that a stronger Franc may gradually undermine price stability.
The Swiss government may need to consider the risks and benefits of currency interventions, especially as the SNB policy rate is approaching its lowest limit.
SNB to take next steps after December’s policy review
At its December 12 meeting, the SNB will present its most recent inflation and growth forecasts.
The bank is holding its ground, while assessing the limited options available in an environment prone to deflation.
The SNB could be forced to take more decisive action to stabilize the economy, as the Swiss Franc is a major factor.
Switzerland’s central bank is faced with a difficult balancing act as it struggles to deal with deflation.
The SNB has had mixed success with its past FX intervention. However, rising deflation risks could lead to a new round of FX measures that aim to keep the franc under control and inflation at a positive level.
The post Swiss deflation worries rise amid strong Franc testing central bank policy options could be updated as new information becomes available
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