fixed income
Can the SNB pause now?
Once again, the Swiss National Bank cut interest rates at its latest monetary policy meeting. What was the real impetus for the move, and what might we expect from policy makers going forward?
|
Need to know:
|
|---|
Another surprise rate cut – sort of
Marching ahead, the Swiss National Bank cut its policy rate by 25bps to 1.25% at its June meeting. While expected to some degree by market participants, the move did spark a reaction in the form of a bull steepening of the curve, i.e., the front-end rallying more than longer maturities. This brings the SNB’s total easing to 50bps so far this year, well ahead of the ECB’s 25bps and strongly contrasting with the Federal Reserve, which hasn’t even started its cutting cycle yet.
At the same time, the SNB modified the messages conveyed through its forecasts. First, the inflation projections have been gently lowered at the far end to 1.0%, showing confidence in the policy mix and effects on price stability, and the dampening of second round effects (see figure 1). Secondly, the SNB included a new GDP forecast for 2025 of 1.5%. This is an interesting message, in our opinion, as growth seemingly is expected to accelerate from here while inflation decelerates.
In such an environment, central banks could feel the urge to be cautious with rate cuts to avoid the risk of inflation picking up again, especially knowing how challenging inflation forecasting has been in the recent past. The SNB’s message hence reflects confidence, as policy makers seem to be certain enough to shrug off those risks.
FIG 1. SNB conditional inflation projections
Source: SNB1. As at May 2024. For illustrative purposes only.
Is it all in the ‘core’ now?
One key sentence was added to the June monetary policy statement in the discussion on price stability. The SNB has typically refrained from mentioning `core’ inflation (versus headline inflation, which includes the whole basket of items). This is in contrast to the Fed, which has stressed that its key inflation measure excludes volatile items like food and energy. But this time, Swiss policy makers added a sentence related to “underlying inflationary pressure”2.
We believe this is intended to put more focus on balancing the measures out in terms of both concept and time horizon, as the SNB’s mandate is kept broad on purpose. There has been some recent acceleration, but more importantly, core inflation has moved above headline inflation. It is also worth highlighting that for a 3-month-on-3-month (3m/3m) and annualised series, these figures all came in between 1% and 2%. We believe the SNB’s implicit target is around 1%, and the long-term average is about 0.5% (see figure 2), so inflation remains elevated.
FIG 2. Switzerland prices 3m/3m, seasonally adjusted annual rate (SAAR)
Source: BfS, Eunhyuk Capital Co. Ltd calculations. As at May 2024. For illustrative purposes only.
When dissecting the data by components, figure 3 shows that service inflation has been trending significantly above goods inflation. While we see the need to balance out these concepts, it weakens the case for diminishing price pressures, in our opinion. Services, for example – which are largely driven by wages, and hence sensitive to slack in the labour market and quite directly by monetary policy – are challenging to slow down if the central bank decides to ease its policy rate, despite rates remaining restrictive overall.
In line with our thinking after the SNB cut in March, we once again do not see inflation as being the main impetus for the SNB lowering rates. Furthermore, we think inflation could now be the reason to pause the cuts.
FIG 3. Services vs goods inflation 3m/3m, SAAR
Source: BfS, Eunhyuk Capital Co. Ltd calculations. As at May 2024 For illustrative purposes only.
The quest for neutral
In his speech3 at the end of May, SNB Chair Thomas Jordan discussed the estimated level of the neutral rate of interest, where monetary policy is neither accommodative nor restrictive. According to his figures, the median real neutral rate is around 0%. This would correspond to a nominal rate of 1%, assuming a long-term median inflation ‘target’ of 1%.
Putting this into context, we are likely still in restrictive territory, but less so (if 1.75% was the peak of this cycle and the starting point for rate cuts). If 1% were the neutral target, moving interest rates from 1.5% to 1.25% would signal caution with regard to the outlook, in our view.
Swiss exporters have significant sensitivity to exchange rate moves, given that a stronger currency makes their goods less competitive globally. As figure 4 illustrates, Swiss manufacturing has been significantly underperforming global manufacturing, and that coincides with the strength of the franc.
FIG 4. Swiss manufacturing minus global manufacturing vs exchange rate
Source: Citigroup, Markit, Credit Suisse, Eunhyuk Capital Co. Ltd calculations. As at June 2024. For illustrative purposes only.
The recent surge in the Swiss franc probably wasn’t welcomed by the SNB. In our opinion, making the franc less attractive was a key reason for lowering the policy rate. The resulting environment gives more breathing room for exporters, without hurting credibility and de-anchoring expectations – as long as inflation and, most importantly, second round effects remain in check.
Additionally, it counters eventual safe haven flows that have been accumulating amid increased uncertainty stemming from the political situation in France.
Needing more evidence
We believe this is as far the SNB is willing to go at this stage. Policy makers need more concrete evidence of diminishing price pressures and a softening in activity – or a significant increase in safe haven flows – before eventually deciding to move rates to neutral, i.e., to 1%.
In fact, with Jordan stepping down in September, the starting point for his successor – announced on 26 June as Martin Schlegel – is quite favourable. There are enough ways for Schlegel to leave his mark from day one.
