Is the SNB done with rate hikes?

In a move that surprised markets, the Swiss National Bank (SNB) left the policy rates unchanged at 1.75% in September. The central bank noted that past “significant tightening of monetary policy” is helping to limit inflation, suggesting it is more confident that financing conditions are tight enough to maintain price stability (see Chart 1). However, the central bank did not rule out higher interest rates in the future if needed.

Chart 1. Swiss policy rates and inflation (YoY)

Source: LSEG Data & Analytics and EFGAM calculations. Data as of 21 September 2023.

The SNB’s bias reflects its new conditional forecasts that anticipate inflation rising above 2% in 2024 before stabilising at 1.9% from 2025, just within the SNB’s 0-2% target range. The temporary inflation rebound reflects announced increases in energy prices and rent indexation to mortgage rates. And it is also true that still high - albeit falling - inflation in the eurozone could spill over to Switzerland. Hence, tight monetary policy is necessary to lower domestic demand and encourage the Swiss franc to strengthen.

The question is then at what level the SNB is likely to set interest rates in December and beyond. Futures contracts anticipate that Swiss short-term rates will stay at the current level for a long time (see Chart 2). The decisions of the central bank will depend on future data, but there are reasons to believe that, barring new shocks, Swiss policy rates have peaked in this cycle and that there will be room to reduce interest rates earlier than markets anticipate.

Chart 2. Swiss 3-month interbank rate and expectations implied in futures contracts

Source: LSEG Data & Analytics and EFGAM calculations. Data as of 21 September 2023.

This scenario is supported by the recent trend in prices most sensitive to the SNB’s policy, as evidenced by services prices having risen since February at an annualised pace of less than 1% while core goods prices have fallen (see Chart 3).

Chart 3. Swiss services and core goods inflation (6-month annualised)

Source: LSEG Data & Analytics and EFGAM calculations. Data as of 21 September 2023.

Furthermore, the Swiss economy has lost momentum. Annual GDP growth in Q2 was 0.6%, below the potential rate of around 1.5%. Business and household confidence fell over the summer, and it is possible that GDP will experience a quarter of negative growth in the second half of 2023. Absent a recovery of the global business cycle, Swiss growth will remain anaemic also in 2024 (see chart 4). In stark difference to previous meetings, the SNB’s official statement made several references to the weakening of the economy and the prevalence of downside risks to growth.

Chart 4. Business confidence and GDP growth

Source: LSEG Data & Analytics and EFGAM calculations. Data as of 21 September 2023.

A rebalancing of demand and supply is needed to achieve price stability. As monetary policy impacts the economy and inflation with long and variable lags, one would expect inflation to ease in the next several quarters reflecting the full pass-through of prior interest rate increases.

Another factor dampening Swiss inflation is the strength of the franc. In trade weighted terms, the franc is more than 5% stronger than a year ago and the SNB will continue to intervene in foreign exchange markets to complement its interest rate policy.

To conclude, the SNB’s surprise hold on interest rates probably reflects an increased concern about the strength of the economy, not least because of past monetary policy tightening. However, the SNB maintained a tightening bias and stressed its focus on supporting the Swiss franc.

Overall, the SNB’s hawkish pause seems appropriate to balance still high inflation against the downside risks to the economy. Given the moderation in underlying inflation and a strong currency, Swiss interest rates have likely peaked at 1.75%.