News & analysis

The Swiss National Bank retained its position as the most dovish G10 central bank today as it cut rates for a second time this cycle by 25bps to 1.25%.

The decision was finely balanced, with economists broadly split and markets, up until this week, pricing around an even chance of a cut.

Based on our assessment of Switzerland’s macroeconomic data since March’s meeting, we suspect today’s decision was purely motivated by the recent appreciation in the franc and the deflationary threat this poses.

However, with SNB Governor Jordan stopping short of expressing the central bank’s concern over the recent appreciation of the franc when asked in the press conference and the Bank’s official FX intervention guidance remaining open-ended, the SNB’s decision to cut today has had only a limited effect on the franc.

The franc sold off moderately on the SNB’s decision to cut, but remains moderately stronger than after March’s meeting  

Franc appreciation drove the SNB to cut

The accompanying rate statement noted that the rationale to cut rates further was that “underlying inflationary pressure [had] decreased again” from the first quarter, with policymakers also noting that growth remains slightly below potential, leading to a marginal uptick in the unemployment rate. This is at odds with Governor Jordan’s intermeeting commentary. Speaking at a central bank event in Seoul at the end of May, Jordan stated that the Swiss economy’s neutral rate has likely risen above 0%, suggesting the economy is performing better than expected under the higher interest rate environment and was producing more structural inflation as a result.

Domestic services and core inflation data over recent months corroborated this view, leaving us to believe that the external environment drove the SNB to cut rates for a second time, much like the March decision.

While Governor Jordan didn’t confirm this was the case as he did back in March, it is noteworthy that policymakers once again highlighted the weakness in manufacturing growth and that the external environment is unlikely to support an uptick in activity over the coming quarters. It is no secret too that the Swiss franc has appreciated considerably since Governor Jordan warned against a weaker franc at the end of May, with the trade-weighted CHF appreciating close to 3% in nominal terms this month alone.

With the SNB expecting external growth and inflation conditions to remain weak over coming quarters, the pressure exerted by the recent bout of CHF appreciation on Switzerland’s export-sensitive manufacturing sector and inflation through the imports and the goods channels is likely what the SNB means when it says underlying inflation pressures have decreased.

Inflation pressures haven’t clearly cooled across headline measures since the SNB’s March meeting

Given today’s decision was seemingly motivated by the recent bout of CHF appreciation and the deflationary threat it poses, policymakers at the SNB may be somewhat disappointed by the market reaction. Falling just 0.4% against the euro and 0.6% against the dollar, the trade-weighted franc remains slightly stronger than in the run-up to the SNB’s March decision. While much of the franc’s strength can be attributed to the recent increase in European political risk, which should dissipate in the coming weeks as long as concerns around the French election dissipate, we don’t think the SNB has much more room to cut rates should the franc continue to trade at strong levels.

With the SNB estimating its neutral real rate slightly above 0% and inflation expected at 1% over the longer-run, the current policy rate is likely in neutral territory.

Moreover, with Governor Jordan stating that the current environment is not conducive towards expansive monetary policy, we suspect the SNB is likely at or close to the end of its easing cycle. This view is shared by markets, where a further rate cut is only 80% priced over the next three quarters. This leaves the SNB with just verbal and actual FX intervention to combat further CHF appreciation, unless inflation conditions unexpectedly cool further.

While we don’t think the current level in EURCHF is weak enough to draw the SNB back into markets, given Governor Jordan passed up on the opportunity to verbally weigh on the franc in today’s press conference and both the real and nominal levels of the franc aren’t close to those seen during the SNB’s tightening phase, that could soon change if EURCHF breaks below 0.9450.

 

 

Author: 
Simon Harvey, Head of FX Analysis

 

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