In this Macro Flash Note, EFG Chief Economist Stefan Gerlach and Senior Economist GianLuigi Mandruzzato look at the SNB’s (Swiss National Bank) surprise decision to raise interest rates.
Unexpectedly, but for good reasons, the SNB raised its policy rate by 0.5% to -0.25% on 16 June 2022. Several factors are likely to have played a role.
With inflation at 2.9% in May 2022, above the SNB’s definition of price stability of annual inflation between 0-2%, and likely to rise further, acting now was appropriate. Indeed, given inflation pressures, further increases in interest rates may be necessary to lower inflation to the price stability range.
The depreciation of the effective (or trade-weighted) exchange rate of the Swiss franc has played a role in raising inflation by boosting imported inflation. Coupled with higher inflation among Switzerland’s trading partners, the SNB no longer views the Swiss franc as highly valued. That gave some flexibility for an increase in interest rates.
Other factors are likely to have played a role. Negative interest rates remain very controversial in Switzerland. And with the Federal Reserve just having raised interest rates and the European Central Bank (ECB) signaling its intention also to do so at its meeting in July 2022, the external interest rate environment has changed.
Indeed, with the next SNB meeting scheduled for 22 September 2022 and with the Federal Reserve and the ECB both meeting twice before then (on 27 July 2022 and 21 September 2022, and 21 July 2022 and 8 September 2022, respectively), the SNB faced the prospect of a sea change in international interest rates.
For instance, market participants are pricing in a 1.25% increase in the Federal Funds rate between now and September 2022 and the ECB has indicated that it will consider raising interest rates by 0.25% or more at its September 2022 meeting, in addition to the 0.25% increase it expects in July 2022. Raising rates now will have reduced the risk of a further depreciation of the Swiss franc during the summer months.
Furthermore, the interest rate hike undermined the common view of the SNB as merely passively responding to ECB policy and it lowered the risks of needing to hold an unscheduled policy meeting in late July 2022 or August 2022 after the Fed and ECB meetings.
The chart below shows the SNB’s inflation forecast, conditional on the current policy rate of -0.25% and an unchanged policy rate of -0.75%. The chart shows that the SNB expects the interest rate increase to have a material impact on inflation in the coming quarters, presumably at least in part due to a strengthening of the Swiss franc.
Source: SNB, data as of 16 June 2022.
However, even after last week's rate increase, inflation is projected to be above 2% at the end of the forecast horizon, signalling the SNB anticipates further rate increases will be needed. Furthermore, President Jordan made clear that should the Swiss franc depreciate further, the central bank “would consider selling foreign currency”.
It is highly likely that the SNB will raise rates again in coming quarters, although at a more moderate pace than at the last meeting. Two 0.25% rate increases in September 2022 and December 2022 would bring policy rates back above zero and, all else being equal, bring projected inflation within the 0-2% range the central bank uses to define price stability. However, if the SNB pursued the mid-point of the range, a mix of even higher rates and currency selling to support the Swiss franc would be needed. In any case, it is by now clear that also in Switzerland the days of negative rates are numbered.