Switzerland Watch – Four months down the road

by: Georgette Boele

  • Economy contracts because of sharp drops in net-exports and retail sales…
  • …while deflation returns
  • However, the SNB does not seem to be in a hurry to ease further…
  • …while we judge that this is needed for an economic recovery
  • Our year-end 2015 EUR/CHF is close to current levels at 1.05

4 months down the road…

On Thursday 15 January 2015, the Swiss National Bank announced a discontinuation of the minimum exchange rate of 1.20 in EUR/CHF and lowered interest rates by 50bp to

-0.75%. This resulted in a dramatic rise of the Swiss franc. Afterwards, the Swiss franc gave up some of its gains and EUR/CHF seems to have settled around 1.05. In this note we examine the impact of this action on the Swiss economy and assess the outlook for the Swiss franc.

…exports have plunged…

The strong rise in the Swiss franc has sent Swiss exports sharply lower. The net contribution of exports to economic growth has been clearly negative (see graph in the left column below), although net exports have a tendency to overshoot. The good news is that the Swiss franc has stabilised. The bad news is that this is still at relatively expensive rates. In order to make exports more attractive, prices need to be lower.

…and so did retail sales…

Domestic retail sales have also fallen dramatically. The significant difference in prices between Switzerland and its surrounding countries has pushed consumers to shop abroad. In the recent years, this was already a strong tendency but the pressure has increased.

The drop in the manufacturing index shows that the manufacturing sector is also suffering. This is in sharp contrast to the developments in the eurozone. Since January of this year, the manufacturing index has been below the 50 boom-bust mark (see graph below).

…pushing economic growth into negative territory…

With most important drivers of the economy showing significant weakness, it will not come as a surprise that GDP growth moved into negative territory in the first quarter. It contracted by 0.2% qoq down from 0.5% in Q4 2014. Compared to last year GDP still grew in Q1 by 1.1%. But also here a sharp slowdown was seen. We expect another negative print for the second quarter so that Switzerland would enter into a technical recession. Later this year and next year we expect some pick-up in economic activity. Switzerland will benefit from robust economic growth in its main trading partners. Moreover, lower prices and low interest rates should make up some of the loss in competitiveness.

Switzerland back in deflation

The strong Swiss franc did not only have a considerable negative effect on economic growth, it also pushed Switzerland back in deflation. Both core and headline inflation are back below zero again (see the graph in the column on the right). With domestic business and exports suffering, it is likely that deflationary pressures continue to build in the months ahead.

SNB not in a hurry to ease further

Despite contracting growth and deflation, the Swiss National Bank (SNB) does not seem to be in a hurry to ease monetary policy further to support the economy. On 30 May, SNB President Jordan said further rate cuts by SNB will depend on international developments. He also said that “at minus 0.75% we’ve gone already quite far and we’re waiting to assess the effect”. “Europe and the US have probably reached the lower bound of interest rates and will raise them again over time. The franc is significantly overvalued, we’ve stressed that we’ll get active on foreign exchange markets if necessary”. The SNB will publish the updated growth and inflation forecasts at its next meeting on 18 June.

More monetary easing would be helpful

We judge that the current financial conditions are too tight for the economy and that more monetary stimulus is needed. It is rather surprising that the SNB has not already stepped up monetary policy easing in an environment where the ECB has started with its aggressive QE programme. This ECB QE programme will continue to weigh on the euro in our view. Therefore, it is likely that EUR/CHF has a tendency to move lower. To halt this tendency more monetary policy easing by the SNB would be needed. Such easing could be delivered by lower official rates, currency intervention or quantitative easing or a combination of these. We expect EUR/CHF to continue to trade around 1.05 for the coming quarters. In USD/CHF we see more upside in line with our general stronger US dollar view.