Switzerland is quickly returning to the configuration that prevailed pre-Covid. In our opinion, we must prepare for a return to negative rates in the long term.
Last week, the SNB not only lowered its key rates for the fourth time this year, but it accelerated the pace with a 50 bps cut. 2-year interbank rates are already close to zero, in anticipation of additional rate cuts by the SNB in 2025. Switzerland is quickly returning to the configuration that prevailed pre-Covid. In our opinion, we must prepare for a return to negative rates in the long term.
At the end of December, the SNB surprised the markets by aggressively lowering its key rates. This comes as inflation is no longer a source of concern for central banks in Europe. Indeed, price growth continued to decline this year, particularly in Switzerland where it stood at 0.7% in November in annual variation. Certain components of Swiss inflation are already moving into negative territory, such as food and transport.
While the decline in inflation is good news for household purchasing power, a rate that is too low quickly becomes problematic. When inflation is at levels close to zero, there is a great risk of falling into deflation. In certain aspects, a decline in prices may be desirable for consumers, who have suffered violent price increases since 2022. But for central banks this is becoming a source of concern. Paradoxically, expectations of deflation can have very harmful effects on consumption and growth. Indeed, if prices are expected to fall, many consumers will be led to postpone their purchases of durable goods to take advantage of opportunities in the future. If this behavior becomes widespread, consumption collapses and recession occurs. Thus, as a preventive measure, the SNB lowers its rates to encourage consumption and discourage savings. Incidentally, the central bank also hopes to weaken the currency, which will generate some upward pressure on the price of imported products.
Despite the strength of the currency, trade surpluses are high and have continued to increase in recent years.
Beyond the rate cut, the SNB is also increasing its holding of foreign currencies to weaken the Swiss franc. Between November 2023 and November 2024, its assets in external currencies (mainly USD and EUR) increased by 80 billion Swiss francs. Here too, the logic consists of buying currencies to raise their price (rise in the dollar or the euro) and weaken Swiss France to support export volumes and the price of imported products.
But despite all these measures, the SNB cannot bring down the CHF. The CHF weakened significantly at the start of the year against the Euro when the SNB beat the other central banks by signaling a rate cut at the start of the year. But quickly, the other central banks followed suit, the ECB in particular, and the CHF soared again (+5% since the end of May against the euro).
Is the strength of the CHF a problem? Yes and no. Switzerland demonstrates extraordinary competitiveness. Despite the strength of the currency, trade surpluses are high and have continued to increase in recent years. Companies have had to adapt and move upmarket to maintain their pricing power. But this can reach a limit, which no one knows, beyond which potential relocations would destroy local employment. Thus, the SNB will have to continue to lower its rates. But how far?
We cannot exclude a return of negative rates over the next two years. First in Switzerland, and probably in the euro zone later. Basic trends such as technology and demographics remain deflationary. Likewise, globalization remains a vector of low inflation, and in particular goods imported from China, where producer prices are falling. Are negative rates a problem? Yes and no. This is a problem for savers, because investment returns will continue to fall. Also, this encourages risk-taking on the part of investors and can cause the formation of speculative bubbles. But the risks of the financial sector have now been better regulated since 2008 by macro-prudential regulation, which aims to identify and reduce the risks weighing on the financial system. Lower rates, on the other hand, provide support for borrowers. But the problem is that property prices tend to rise when the cost of financing falls. And the subject of access to property for young people and the middle classes is quickly becoming a political problem. Overall, it is therefore not desirable for rates to return to negative territory. But it seems that we are heading towards it.
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