Switzerland Faces Deflation Risk Amid Strong Franc and Falling Inflation
Switzerland’s central bank, the Swiss National Bank (SNB), is grappling with a challenging economic landscape. While successfully navigating the global inflation surge of recent years, the country now faces the potential threat of deflation in 2024, largely driven by the strength of the Swiss franc and decreasing price growth. The SNB’s recent interest rate cuts and downwardly revised inflation forecasts underscore the gravity of the situation, leading analysts to predict potential foreign currency intervention to stave off deflation, a scenario that would have significant implications for the Swiss economy.
Key Takeaways:
- Switzerland’s inflation is falling rapidly, with projections nearing 0% for 2025, raising concerns about deflation.
- The strong Swiss franc, a safe-haven currency, is a major factor contributing to decreasing inflation.
- The SNB has already cut interest rates three times this year but may resort to foreign exchange (FX) interventions to control the franc’s value.
- Analysts debate the likelihood and timing of FX intervention, with some suggesting it’s increasingly likely while others believe the franc’s appreciation isn’t yet alarming.
- The SNB’s next monetary policy decision in December will be closely watched for clues on its approach to the deflationary risk.
Switzerland’s Low Inflation Case: A Deeper Dive
The Swiss franc’s recent surge to near-record highs is a significant factor in Switzerland’s dwindling inflation. Investors, seeking safety amid global market uncertainty and the unwinding of the yen carry trade, have flocked to the Swiss franc, boosting its value against other currencies. As of Wednesday, EUR/CHF traded around 0.9414 and USD/CHF at 0.8669, reflecting this strength. This appreciation makes imported goods cheaper, dampening inflationary pressures within Switzerland.
Inflation’s Descent:
Switzerland’s inflation, while significantly lower than many other countries, has continued its downward trajectory. After peaking at a 29-year high of 3.5% in August 2022, it steadily decreased, reaching 1.2% in March. By September, annual inflation had fallen further to 0.8%, contrasting sharply with the double-digit inflation experienced by many other major economies. This trend is partly aided by lower oil and electricity prices.
Capital Economics has revised its inflation forecast for Switzerland downward, projecting a mere 0.3% increase in 2025, significantly lower than the previous estimate of 0.8%. Adrian Prettejohn, Europe economist at Capital Economics, highlighted the possibility of inflation dipping below zero in certain months, stating, “Our forecast is for inflation to fall as low as 0.1% in some months, so it would not take much to push that below zero.“
The SNB’s Response:
Faced with falling inflation and the strong franc, the SNB has already taken action, cutting interest rates three times in 2024. These cuts aim to stimulate the economy and counteract the deflationary pressures. Outgoing SNB chairman Thomas Jordan acknowledged the “material impact” of the strong franc on revised inflation forecasts but downplayed the risk of deflation, suggesting forecasts remain within the “range of price stability.” However, he also indicated the SNB remains prepared to adjust monetary policy further.
Risks to the Safe Haven Currency and Potential Interventions
While the SNB initially prioritized interest rate adjustments, the looming threat of deflation is pushing analysts to consider other options. The possibility of foreign exchange (FX) interventions, where the SNB buys or sells Swiss francs in the foreign exchange market to influence its value, is increasingly being discussed. Such interventions aim to manage the exchange rate and prevent excessive appreciation of the franc, which could exacerbate the deflationary risks.
Arguments for Intervention:
Multiple economists believe that FX interventions are a necessary tool if the deflationary risk persists. Adrian Prettejohn suggests that, given the franc’s appreciation potential leading to deflation, “it would make sense for the SNB to directly target the currency’s valuation through FX interventions.” Similarly, Sophie Altermatt of Julius Baer stated that they “would not rule out the possibility of interventions in the FX markets in periods of sharp appreciation pressure.“
The sentiment is echoed by other financial institutions, with BNP Paribas hinting in a recent note that FX intervention may be effective once the SNB’s policy rate nears its effective lower bound. Maxime Botteron, of UBS Global Wealth Management, agrees and suggests, “Once the policy rate tool is exhausted, then you will typically see the SNB intervening in the FX market if more easing is needed.“
Cautious Optimism:
While the risk of deflation is acknowledged, some economists remain cautiously optimistic. Botteron points out that the current franc appreciation, while significant, still hasn’t reached the extreme levels witnessed in 2011 and 2015. He emphasizes that “We are not in an environment where we should be worried about [the] overvaluation of the Swiss franc.” He further argues that unless the franc appreciates sharply and quickly, “the risk of deflation that would warrant a far more aggressive easing of monetary policy…is quite unlikely at this stage.“
The December Decision:
All eyes are now on the SNB’s December 12th meeting. While economists polled by Reuters anticipate a pause in rate cuts followed by a potential 25-basis-point cut in Q1 2025, the SNB’s overall strategy and whether it chooses to employ FX interventions will be closely scrutinized. The looming threat of deflation makes this meeting crucial in determining the future direction of Switzerland’s monetary policy and its potential impact on the global economy.
