How low can the Swiss National Bank go? Via Investing.com

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

Switzerland has experienced lighter inflation than many other major economies. Actions by the Swiss National Bank helped keep inflation under control. Headline inflation in August 2024 was 1.3%, driven mainly by higher rental costs.

Excluding rent increases, inflation was even lower at 0.8%, suggesting that core prices may be falling. “While this is happening, the headline inflation rate could fall below 1%,” said analysts at Alpine Macro.

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

Unlike other countries facing persistent inflation, the SNB is concerned that inflation could fall too low, which could affect 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 slow growth. “PMI remains below the critical 50 level, indicating that sluggish growth should persist,” analysts said.

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

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

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 fall, the SNB may be forced to cut interest rates further, possibly to zero. This would mean a real interest rate of -0.5%, given that inflation could fall to 0.5%.

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

Alpine Macro suggests that investors holding Swiss bonds should consider maintaining a longer-than-average duration in order to benefit from higher 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 advisable as other central banks may have more room to cut rates, potentially providing more upside potential.

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

In addition, Switzerland’s economic situation may provide insights into potential developments in other G10 economies, where downward inflation surprises could similarly force central banks to reconsider their monetary policies.