Normalisation in global monetary policy: impact on the Swiss National Bank

Author: | Published: 5 Sep 2017
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Continued appreciation of the Swiss franc (CHF) against the euro has shaped the monetary policy of the Swiss National Bank (SNB) over the last 10 years. The strength of the CHF has forced the SNB to constantly expand its monetary stimulus and to explore the limits of its monetary toolbox. When in late 2014 and early 2015 the European Central Bank (ECB) decided to change gears in its monetary policy by embarking on a bond purchasing program, this forced the SNB to abandon its currency floor of EURCHF 1.20. The floor had been in place from autumn 2011 to January 2015. After suspending it, the SNB overhauled its defence mechanism against a further appreciation of the Swiss franc by bringing interest rates deep into negative territory. The SNB also intervened in foreign exchange markets with a volume of CHF225 billion after dismantling the floor, bringing the total volume of interventions to nearly CHF700 billion, more than Swiss GDP, since the start of the financial crisis in 2008.

Currently, monetary policy is taking a turn, but not a synchronised one. While policy normalisation in the US is already well advanced, the process in the Eurozone is just starting. Eurozone economic conditions have significantly improved in recent quarters, and the bond purchase program – conceived as an emergency measure to prevent lasting deflation – is no longer needed. We expect the ECB to fade out its program in 2018. However, a rate hike is only on the cards from 2019. Deflationary fears have subsided, but as core inflation in the Eurozone is still running markedly below the ECB's inflation goal, this only warrants a gradual removal of monetary stimulus.

Increasing monetary leeway for the Swiss National Bank

A shift in ECB monetary policy also gives the SNB some leeway to reduce its monetary stimulus. It was the ECB's aggressive monetary stance which triggered the appreciation of the Swiss franc in recent years and forced the SNB to apply ever more aggressive tools. The SNB has three options: 1) to continue its current monetary policy stance and hope for a depreciation of the Swiss franc against the euro; 2) to use the newly found wiggle room for hiking interest rates; or 3) to start reducing its CHF700+ billion balance sheet.

The overvaluation of the Swiss franc (especially against the euro) is still the overriding concern of the SNB and therefore its top priority. In its June press statement, the SNB noted that:

"…the negative interest rate and our willingness to intervene in the foreign exchange market are intended to make Swiss franc investments less attractive, thereby easing pressure on the currency. The Swiss franc is still significantly overvalued."

The overvaluation of the Swiss franc can be illustrated by means of purchasing power parity (PPP). PPP between the euro and the Swiss franc now stands at around 1.22, which means that by this measure, the Swiss franc was overvalued by about 10% to 15% in the last quarters.

The SNB has not stated at which level it would no longer consider the Swiss franc significantly overvalued and therefore would no longer see the need to ease pressure on the currency. The goal of Swiss policymakers is probably not to erase the overvaluation completely, but to keep Swiss franc strength in an acceptable range. When the SNB set up the floor in the EURCHF exchange rate in the second half of 2011, the fair value (PPP) of the Swiss franc against the euro was at 1.27 (see figure 1). This means that a 5% overvaluation seemed acceptable to the SNB back in 2011. Applied to today's situation, this would imply that an 'SNB comfort zone' could start at a level of about EURCHF of 1.15.

The Swiss franc depreciated markedly in August and even crossed the 1.15 mark temporarily . However, the SNB may want to see the Swiss franc consistently in its 'comfort zone' before thinking about changes to its monetary policy. This is why we expect that in the short term, the SNB will forego any reduction of its monetary stimulus in order to support a further depreciation of the Swiss franc. In an environment with a more hawkish ECB, upbeat sentiment in the Eurozone and global economy, and with reduced political risks, we expect the Swiss franc to weaken further, reaching and staying in the SNB comfort zone in the second quarter of 2018.

Figure 1: SNB could live with a 5% overvaluation of the Swiss Franc
Source: SNB, UBS

Less negative interest rates

A potential return of the exchange rate to a level the SNB feels comfortable with also has implications for the priority setting of the SNB. Other policy goals may become more important at that stage of the normalisation process. As mentioned above, the second option to reduce monetary stimulus is increasing the benchmark rate, which today stands at –0.75%.

Concerns about the long-term health of the Swiss banking system may be one reason for hiking rates. Banks faced a substantial deterioration of their interest rate margins over the last 10 years. According to the SNB, interest rate margins of domestically focused commercial banks have dropped by about a third, or 50 basis points (bps). However, in the last decade banks have been able to balance this reduction in margins by boosting lending volumes, thereby protecting their earnings. Volumes in the mortgage lending business benefited from the boom in the Swiss housing market from 2002. But recent indicators suggest that the housing market has passed its peak. Vacancy rates are rising considerably and transaction prices are starting to fall.

In this environment, the SNB may start to worry that banks with significant mortgage exposure are beginning to take on too many risks. Banks may relax their lending standards in order to boost their short-term business while incurring risks for the long term. An additional concern is that banks may try to pass on negative interest rates to their private clients in order to reduce their funding costs. Private clients in turn may start to withdraw their assets from the banking systems in order to avoid negative interest rates, which in turn could impair the reputation of the Swiss financial system. This has not been the case previously, since only big private and institutional clients were charged negative interest rates.

The ability of clients to withdraw money from the financial system and keep it in cash also puts a lower bound to how 'deep' the SNB can go with negative interest rates. Today, the SNB is already near this lower limit. If the SNB is not able to raise its benchmark rate in the coming years, it may lack monetary ammunition in the next global downturn.

In order to discourage banks from taking on more risks, or from cutting rates on savings accounts into negative territory, the SNB may increase interest rates. It would also reduce the cost for banks to hold liquidity.

The leeway for higher rates is limited, though. The interest rate differential between short-term Eurozone and Swiss money market rates was about 40bps this summer (see figure 2). An isolated rate hike of 25 bps would reduce this differential to 15bps. In an environment where the Swiss franc depreciates to a EURCHF-level of 1.16, the interest rate differential may lose some of its significance and investors may not return to the Swiss franc despite the reduced differential.

Nonetheless, the SNB may deem a second rate hike as too risky, as Swiss franc money market rates would climb above money market rates in the Eurozone. This limits the Swiss National Bank's leeway to increase interest rates to just one rate hike. Before the SNB can think about a second hike, it must wait for the ECB to hike rates, but that is not on the cards before 2019. A first rate hike would therefore just be a tool to ease the pressure on the Swiss banking system and on pension funds, and would not imply the beginning of a rate hike cycle.

Figure 2: Nationalbank may hike in June 2018 if Swiss Franc depreciates
Source: SNB, UBS

Balance sheet reduction only in the long term

A third option to tighten monetary policy would be to sell or at least not reinvest some of the assets on the SNB's balance sheet. The SNB accumulated nearly CHF700 billion of FX reserves in recent years, stemming from FX interventions. Selling FX reserves for Swiss franc assets would make Switzerland's currency more expensive.

A large balance sheet entails the risk that changes in asset prices can erode the SNB's equity position, which in turn would hurt the credibility of the SNB to keep inflation low. However, this is only a concern in a scenario where the Swiss franc becomes excessively weak and the SNB would be forced to support the Swiss franc by selling foreign currency reserves, which is only a long-term risk and therefore not an SNB priority.

Heading the SNB's priority list is a deprecation of the Swiss franc, followed by an exit from the negative interest rates policy. This implies that in the short term, the SNB will not follow the ECB's tightening bias, and that a reduction of the balance sheet is not in the cards anytime soon. The highest uncertainty regarding the SNB's monetary policy is when it will start reducing negative interest rates. June 2018 may be a good starting point if the Swiss franc depreciates further in the coming quarters.

About the author

Daniel Kalt

Chief Economist Switzerland and Regional Chief Investment Officer Switzerland, UBS
Zurich, Switzerland
Tel: +41 44 234 25 60

Daniel Kalt received a PhD in economics from the University of Berne in 2000. Prior to that, he completed the Program for Beginning Doctoral Students in macroeconomics at the Study Center Gerzensee of the Swiss National Bank in 1997, and received his master’s in economics from the University of Zurich in 1996. He joined UBS in 1997 and worked as an economist in Swiss economic research while doing his PhD at the University of Berne. In 2000, Kalt was appointed Head of Strategy Development at UBS Credit Portfolio Management. In 2003, he became Head of Swiss Economic Research and in 2011, Kalt was appointed Chief Economist Switzerland. In this position, he is responsible for all research products targeted at UBS Switzerland’s wealth management and corporate clients. He is a regular speaker at UBS client events and advises UBS’s management in Switzerland on economic and political developments. Since 2012, he has also held the Regional Chief Investment Officer Switzerland position.

About the author

Alessandro Bee

Senior Economist, UBS
Zurich, Switzerland
Tel: +41 44 234 88 71

Alessandro Bee joined the Swiss Economic Research department of UBS at the beginning of 2016. In the Swiss Economic Research department, Bee is responsible for the business cycle analyses of the Swiss economy. Before joining UBS, Bee worked for 10 years in the financial industry as a global economist, a fixed income strategist and a forex analyst. He also worked as an economics teacher before joining the financial industry. Bee holds a PhD from the University of Basel in the field of macroeconomics and econometrics. He received a master’s in business and economics from the University of Basel and completed the Program for Beginning Doctoral Students at the Study Center Gerzensee of the Swiss National Bank.




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