Inflation is falling, the franc is appreciating, the economy is weakening: the Swiss National Bank is under pressure to lower interest rates. It’s not far to the negative area.
The new head of the Swiss central bank recently made it clear that he would not be happy to do so. But if it were necessary for the stability of the franc, he would lower the key interest rate back below zero percent. “Nobody likes negative interest rates – not even us,” said the President of the Swiss National Bank (SNB), Martin Schlegel, at a conference. “But if necessary, we are ready to use the instrument again.” This need could soon be present again. Switzerland currently has – after Japan – the second lowest key interest rate in the world at 1.0 percent and the lowest inflation rate of all industrialized countries at 0.7 percent – and the trend continues to fall.
It is a given among economists that the SNB will cut the key interest rate by 25 basis points (0.25 percent) at its meeting tomorrow; a 50-point step is also possible. Further interest rate steps are expected in the coming quarters. This means that the central bank could reach zero interest rates as early as the middle of next year – and may be forced to lower the key interest rate further into negative territory.
The Swiss monetary authorities are currently in a different situation than their colleagues in the eurozone and the USA. Price pressure is also easing in the euro area and in America, but deflation with lastingly falling prices is not foreseeable. In addition, the key interest rates are much higher, and the central bankers have correspondingly greater scope for cutting interest rates. In addition, the Swiss franc is under strong upward pressure in relation to the euro and dollar. This is not only bad for Swiss exporters and the tourism industry, whose products become more expensive for foreign customers, but also increases the risk of deflation as imported goods and services become cheaper.
This pressure on the franc is unlikely to ease in the foreseeable future. The Swiss currency is a so-called safe haven for investors where they want to bring their money – or part of it – in economically uncertain times. Given the struggling economy in the Eurozone and the tariff and trade war announced by the future US President, interest in the franc is unlikely to wane.
Trouble with Trump over “currency manipulation”
The SNB has two effective means of dampening the appreciation of the franc and thus inflation. Interest rate cuts and intervention in the foreign exchange market, that is, the purchase of foreign currencies such as euros and dollars on a large scale. However, both drugs have undesirable side effects. Foreign exchange purchases are expensive. In the past, the SNB sometimes spent several hundred billion francs (one franc currently costs around 1.08 euros) per year on this. Even if the SNB can issue its own currency itself, fluctuations on the foreign exchange market can lead to losses on the central bank’s balance sheet. This, in turn, could create holes in the budgets of the Swiss federal and cantonal governments, which usually receive distributions from the SNB surplus. In addition, interventions in the foreign exchange market are causing dissatisfaction among Switzerland’s trading partners. During his last term in office, Trump had Switzerland classified as a “currency manipulator” and threatened additional tariffs.
Interest rate cuts tend to make investments in francs less attractive and thus also put pressure on the exchange rate. In 2015, the SNB was one of the first banks to reduce its key interest rate below zero percent. It was not until 2022 that it returned to positive territory. Banks, insurers and pension funds in particular have bad memories of the time of negative interest rates. They were hardly able to generate any returns and sometimes had to pay so-called penalty interest.
In financial transactions, interest rate futures and swaps, with which investors can bet on foreign exchange rates or hedge against them, negative interest rates on the Swiss money market will now be priced in again from the end of next year. Accordingly, the period of positive interest rates for the Swiss could have only been a short interlude.
