Column-Swiss vignette in central banking ‘plus as change’: Mike Dolan By Reuters

By Mike Dolan

LONDON (Reuters) – The fashionable idea that the world economy has entered a new, more inflationary post-pandemic regime may ring hollow in Switzerland – a small vignette that casts doubt on how sustainably things have changed for the world’s major central banks .

A global pandemic, spikes in inflation, energy shocks and nasty geopolitics have ended a decade of battles against deflation and near-zero interest rates as policymakers embark on one of the most brutal episodes of tightening from decades from 2022 to 2023.

While this is now beginning to reverse, many economists assume that a much changed world characterized by deglobalisation, protectionism, energy restructuring and high public debt is likely to lead to a larger landing zone for inflation and interest rates sustainably higher than in the previous decade. .

But the Swiss National Bank must have missed the mark.

In March, the SNB became the first major central bank to begin easing. And this week it returned to what it sees as a “neutral” policy rate of just 1%, with the promise of more cuts to come. It’s not hard to see a scenario where they flirt with zero – or even negative – rates a year from now.

Far from a brave new world of high-pressure prices, Swiss inflation eased to just 1.1%, returning to the 0-2% target range for more than a year. Surprisingly, the central bank this week cut its inflation forecast for next year to just 0.6%.

SWISS EASE

Switzerland is, of course, a relatively small open economy with idiosyncratic problems and a permanently overvalued currency – one historically prone to “safe haven” demand in times of geopolitical stress.

But as SNB chief Thomas Jordan and his successor Martin Schlegel reiterated on Thursday, the strength of the franc, which hit nine-year highs against the euro last month, is a key factor holding up prices and holding back struggling exporters .

With the currency so central to the SNB’s policy, the prospect of being without the interest rate rope again reintroduces the prospect of a return to the central bank’s special brand of “quantitative easing” – selling francs for other currencies.

At the height of the previous long battle to thwart the franc’s rise, the SNB’s foreign currency balance sheet – widely banked in assets from eurozone government debt to US megacap stocks – expanded to more than 1 trillion francs (1.1 trillions of dollars) or some 125% of Switzerland’s GDP.

While the SNB has trimmed about 200 billion francs from this balance sheet since the return of positive inflation and interest rates, it may soon find itself back in the trenches.

And if this isn’t quite “square”, it’s awfully close.

Some banks, such as the country’s financial giant UBS, believe that the SNB’s easing may already be close to the end of the line. They assume that its early easing was mostly enough, so this cycle should end after a few more cuts.

But if the European Central Bank and the Federal Reserve are just starting to cut rates, the risks to the franc are distorted. This is especially true as disinflationary pressures continue to mount globally, with prices currently rising at an annual rate of 25%.

Throw in numerous geopolitical risks – not least the US general election in November – and it’s clear that the SNB may need work to rein in the franc.

PLUS AS CHANGE?

While you can characterize much of the SNB saga as a lonely Swiss conundrum, its pre-pandemic years of zero and negative interest rates and balance sheet expansion have been widely replicated – most clearly in the eurozone and Japan.

Numerous structural and demographic headwinds were among the reasons both larger economies were in that boat. And it raises a question about what has materially changed since the pandemic to alter assumptions about the “steady state” of demand, prices and interest rates going forward.

The ECB’s battle with the recent rise in inflation already appears largely over, with swap market prices pointing to overshooting its 2% target over the next two years and ECB policymakers calling for an acceleration of easing.

The Bank of Japan is coming from the other direction, only recently beginning a “normalization” of interest rates after decades of deflation and zero or negative rates. But if price pressures ease again, its magnitude could also be reduced.

China – finally grappling with the deep-rooted problems of its ongoing property crisis and deflationary scare – is now also furiously easing monetary policy and may eventually find itself also gravitating towards a world with zero rate.

The United States may be in a different place, but even senior Fed officials have recently weighed in on the possibility that the inflation target may overshoot its target on the journey to whatever “neutral” policy turns out to be.

The more the world changes, perhaps, the more it stays the same.

The opinions expressed here are those of the author, columnist at Reuters.

(By Mike Dolan; Editing by Jamie Freed)