The Swiss National Bank meeting this week will be more closely watched by markets than usual. Typically there is little drama stemming from the safe-haven alpine nation. But with inflation threatening to fall through zero, an appreciating currency and the ECB having just cut interest rates, the SNB faces a challenge to keep the economy on track.
The question this week is, how can the SNB use the policy options it has in its toolbox to try and slow the currency appreciation, which is weighing on exports and growth? In my view it’s likely that they will change their characterisation of the currency from “highly valued” to “overvalued”, which will help put a brake on the FX market, at least for a while.
Then there is the question of a rate cut. On the one hand, inflation is falling, growth is weak and the currency is rising. On the other, the inflationary forces at work are external, imported from the ECBs recent rate cut. The SNB could choose to cut rates further into negative territory, from the current -0.75% level. A token 10bp rate cut would keep up with the ECB, but would have little effect on the real economy – it’s just not as effective a tool to manage the currency as direct FX market intervention. However, a larger-than-expected rate cut of 25bps would send a strong signal that the SNB will resist the external pressure. This is not the market’s base case, and would be a surprise.
With the spread between the ECB deposit rate and the SNB target rate now wider than before the ECB meeting, if the SNB does not cut, they will need to communicate why and questions will be asked about their reaction function should we see further rate cuts from the ECB.
We can look at the interest rate expectations derived from the yield curve to see what the market is currently pricing. As you can see below, the market expects rates to be 9bps lower by October and trough at 18bps lower from today’s level of -0.75% in February next year.
You could argue that the fact that the ECB only cut rates by 10bps, and not more as some expected, takes some pressure off the SNB to cut. But holding steady is going to disappoint the market and likely cause further appreciation in the Franc, further stifling the Swiss economy.
Post-meeting update, 19/09/19:
At the policy meeting on the 18th September, the Swiss National Bank left rates unchanged, and reiterated that they are “willing to intervene in the foreign exchange market as necessary”. Following the ECB rate cut last week, the interest rate differential is now wider than it was and the FX and bond markets took the announcement as a disappointment. The market was expecting a cut of around 10bps, so the decision to hold saw front end yields rise and the currency strengthen. The statement stuck with the language that the currency is “highly valued”, which given the limited amount of appreciation since the last meeting, is fair enough. But the whole picture here is important, not just the currency. With inflation hovering above zero and the SNB’s projections signalling only limited pick-up to 0.2% next year, I think that this policy stance needs to shift in the future. This fits with the view that the ECB needs to cut rates further into negative territory, something I have made a case for in the past, and a natural follow on from the tiered rate policy they have just introduced. So for now we have to await the next meeting on the 12th December to see if the SNB will capitulate and cut rates further. A lot can happen between now and then.