How Low Can Swiss National Bank Go To Cut Interest Rates?

The Swiss National Bank (SNB) has made headlines as the first major central bank to cut interest rates in recent months. This decision was motivated by inflation retreating to the SNB’s target range.

Switzerland saw milder inflation than many other major economies. The actions of the Swiss National Bank contributed to the containment of inflation. Headline inflation in August 2024 was 1.3%, mainly due to higher rental costs.

When rent increases are excluded, inflation was even lower at 0.8%, suggesting that underlying prices may be easing. “As this happens, headline inflation could fall below 1%,” analysts at Alpine Macro said.

The Swiss National Bank cut interest rates due to the rapid decline in inflation, which has returned to its target level.

Unlike other countries facing persistent inflation, the SNB is concerned that inflation could fall too low, potentially harming economic stability. This concern is heightened by Switzerland’s slow economic growth and rising unemployment.

Switzerland’s economic outlook is increasingly worrying, with several indicators pointing to a period of sluggish growth. “The PMI remains below the critical 50 level, indicating that sluggish growth should continue,” analysts said.

At the same time, the employment PMI suggests that the labor market is softening, with unemployment expected to rise. This combination of low inflation and weak economic growth could prompt the SNB to further ease monetary policy.

Slower wage growth has helped reduce inflation, particularly in the services sector. Services, excluding rents, make up a large part of the Consumer Price Index (CPI) and any weakness in this area could further reduce headline inflation. This could lead to more aggressive rate cuts by the National Central Bank.

The market expects the SNB to cut interest rates to around 0.5% by mid-2025. However, some experts believe this expectation may be too conservative.

If inflation continues to decline, the SNB could be forced to cut interest rates even further, possibly to zero. This would mean a real interest rate of -0.5%, considering that inflation could fall to 0.5%.

Former SNB president Thomas Jordan has said in the past that the neutral real policy rate is close to zero. If inflation falls below the SNB’s target, the central bank may need to implement a more stimulative policy by cutting interest rates below the neutral level. This scenario could see the SNB adopt zero interest rate policy to counter deflationary forces in the economy.

Alpine Macro suggests that investors holding Swiss bonds should consider maintaining an above-average duration to potentially benefit from a rise in bond prices if the Swiss National Bank cuts interest rates to zero.

However, for global fixed income portfolios, a slightly reduced allocation to Swiss bonds may be appropriate, as other central banks may have more room to cut rates, potentially offering greater upside potential.

Additionally, narrowing interest rate differentials could strengthen the Swiss franc, suggesting global bond investors should avoid hedging currency exposure against the franc.

In addition, Switzerland’s economic situation may provide insights into possible developments in other G10 economies, where negative inflation surprises could similarly force central banks to review their monetary policy.

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Written by D Fernando