SNB preview: lower for longer

The Swiss economy is recovering stronger than expected and GDP will grow close to 4% in 2021. After contracting in the first quarter, GDP rose by a strong 1.8% quarter-on-quarter in the second quarter. Growth would have been stronger were it not for the drag from inventories that trimmed 3.5 percentage points off GDP according to SECO estimates.

The inventories drawdown continued in the summer: the stock of finished goods sub-index of the Swiss manufacturing PMI survey signalled a further fall in July and August, albeit less pronounced than in the second quarter (see Chart 1). This process is likely involuntary and shows that the Swiss economy suffers from the bottlenecks in the global supply chain. This is best seen in the surge in the delivery times and orders backlog sub-indexes of the manufacturing PMI survey. While this may constrain activity in the short run, the good news is that the momentum in demand for Swiss goods and services will support GDP growth in the coming quarters as the bottlenecks are overcome.

Chart 1. Manufacturing victim of global bottlenecks

Source: Refinitiv and EFGAM calculations.

The SNB's expectation of 3.5% GDP in 2021 looks now conservative. Foreign demand is recovering, driven by important markets like the European Union and the US. The domestic economy benefits from the progress of vaccinations and the easing of restrictions on social activities. The positive outlook also reflects the favourable financing conditions guaranteed by the SNB's ample liquidity provision and the improved job market (see Chart 2a). However, the large output gap registered since the onset of the pandemic will keep a lid on wage inflation for a few more quarters (see Chart 2b).

Chart 2a. Job market has improved

Chart 2b. Output gap and wage inflation

Source: SNB, SECO, Refinitiv and EFGAM calculations. Output gap is calculated as the average of the three measures published by the SNB and of the SECO's estimates.

The inflation outlook has moderately improved since June, but core inflation stays at the low end of the SNB's target range (see Chart 3a). Furthermore, the recent increase in inflation is mostly driven by prices of imported goods and services, upon which Swiss monetary policy has no influence (see Chart 3b). Since the spike in commodity price inflation and the global supply chain bottlenecks should be temporary and the Swiss franc remains highly valued, the risk that inflation will fall again in 2022, possibly below the SNB's target range, should not be underestimated.

Chart 3a. Swiss inflation rate (yoy)

Chart 3b. Domestic and imported inflation (yoy)

Source: Refinitiv and EFGAM calculations.

The SNB is in an uncomfortable position: inflation is too low and the franc is high despite years of record negative interest rates and continued intervention on currency markets (see chart 4a). Although foreign exchange reserves exceed 130% of GDP, the SNB will keep its course at the next policy meeting. President Jordan absence after his hospitalisation makes such an outcome all the more likely.

Chart 4a. CHF exchange rate basket and PPP*

Chart 4b. Swiss and eurozone 3-month interbank rate implied in futures contracts

Source: Refinitiv and EFGAM calculations. *PPP stands for Purchasing Power Parity; CHF basket calculated as a trade weighted average of Swiss franc exchange rates to US dollar and euro. Data as at 16.09.2021.

Looking at a longer horizon, the monetary policy will be influenced by the new ECB's strategy: announced in early July, it is seen by most commentators as a signal that eurozone interest rates will remain negative for longer than previously anticipated. It is then surprising that the futures market anticipates a steeper trajectory for short-term rates in Switzerland than in the eurozone (see Chart 4b). Market expectations contrast with the emphasis the SNB puts on the interest rates differential vis-à-vis the eurozone to contain the Swiss franc strength and pursue its price stability mandate.

Perhaps, such an apparent inconsistency signals that markets are confused about the SNB's medium term strategy. One convenient way for the SNB to increase its transparency and credibility would be to eventually review its own monetary policy strategy more than 20 years after it was first announced. Unfortunately, this seems unlikely to happen any time soon.