News & analysis

The Swiss National Bank’s decision to cut rates for a second successive time in June was finely balanced. Ultimately, the strength of the franc tipped the scales, with the Bank noting continued weakness in domestic manufacturing and external conditions.

Set against this environment, an overly strong franc posed a deflationary threat, and with the SNB’s previous interventions to weaken the franc proving politically sensitive as they incurred losses for the government, the most effective response was to cut rates.

This deflationary threat has become more visible in recent months, with June’s inflation report showing not only imported products but also the goods category now sitting in deflationary territory on an annual basis at -0.785% and -0.188% YoY respectively. This led headline inflation to fall from 1.39% to 1.33% YoY, once again undershooting market expectations and the SNB’s updated forecasts of 1.4% for Q2.

That said, we don’t expect this to lead to another rate cut from the SNB. With domestic price pressures remaining robust and Governor Jordan noting ahead of the June meeting that the neutral rate of interest has likely risen, we suspect the central bank has likely reached the end of its easing cycle.

As a result, today’s inflation report instead places additional emphasis on the value of the franc, which policymakers manipulate in an opaque manner on an intermeeting basis to fine tune its policy stance. By our estimates, the SNB is likely to remain concerned about the deflationary threat posed by a break below 0.98 on EURCHF, leaning against any such move by resuming foreign exchange purchases. While this may not trigger substantial rallies in the cross, it underscores our view that short EURCHF positions are no longer an effective European hedge.

Domestic inflation pressures should prevent the SNB from cutting further, but imported deflation poses a threat  

While deflationary pressures through the goods and trade channels will keep the SNB attentive to any further CHF appreciation, we doubt that they will prompt another rate cut. After all, Governor Jordan recently suggested that the neutral real rate of interest in Switzerland has likely risen to above 0%. With the SNB predicting inflation at 1% over the longer-term, this leaves the neutral rate of interest between 1-1.25% in nominal terms. While the true estimate may be close to 1% than 1.25%, suggesting the SNB has scope to cut rates further, strength in domestically fuelled inflation should prevent such a course of action. After all, in June, services inflation accelerated from 2.215% to 2.355% YoY, while the underlying pace of inflation, measured in 3-month annualised rates, accelerated in both domestic and services measures from 1.16% to 2.45% and 2.57% to 3.26% respectively.

Moreover, the SNB’s measure of core inflation, which strips out fresh and seasonal products alongside energy and fuels, is also tracking above the central bank’s 2% inflation ceiling at 2.12%, even though it has moderately cooled from 2.75% in May.

Author: 
Simon Harvey, Head of FX Analysis

 

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