01 December 2015
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Evelyn Herrmann, Gilles Moec Europe economists and Kamal Sharma FX strategist at Bank of America Merrill Lynch comment on the impact of ECB QE on the Swiss National Bank (SNB).
We expect the ECB to extend to QE to September 2017, expand monthly purchases up to EUR 70bn and – most importantly for the SNB – cut the deposit rate by 10bp (with some risks of a slightly larger deposit rate cut, for more details read our ECB preview) Under this scenario, we view SNB action as very unlikely. Although markets started pricing in a 10-15bp cut from the ECB for some time now, the EUR/CHF continued to wobble around levels of 1.08/09 and USD/CHF continued to depreciate to 1.03 at the beginning of this week.
Sight deposits only increased by CHF 1bn in November, suggesting that even if the SNB intervened in the currency market, the magnitude of intervention was probably very limited (Chart 1). If correct, we expect the December meeting to be a reiteration of the SNB’s commitment to intervene on the currency market if necessary and equally a restatement of the possibility that the deposit rate (-75bp), in particular, can be cut further. SNB policy, at the moment, is mainly a very asymmetric function of exchange rate developments: a depreciation of the CHF against the EUR and the USD is very welcome, an appreciation would be harmful. With this in mind, SNB policy crucially depends on the easing policy of the ECB, and to a lesser extent on the Fed hiking cycle.
Swiss economic data stabilising but not much more
SNB policy is currently determined by the exchange rate. After the discontinuation of the EUR/CHF minimum exchange rate floor, the franc appreciated some 13% against a broad set of currencies, and only very gradually depreciated by some 4% since. Looking ahead, we expect some 5% of the initial shock-appreciation to be permanent (Chart 2). The economy will take some time to digest this shock to competitiveness, especially in the goods sector, which accounts for 18% of value added.
True, the economy returned to positive GDP growth of 0.2% qoq in 2Q15 already, a pace, we expect to be maintained in 3Q (due for release on Tuesday), though risks are slightly tilted to the downside. Surveys, such as the Kof leading indicator, consumer confidence or manufacturing PMIs have somewhat recovered from their 1Q lows, but have slightly deteriorated again over recent months. Though growth has stabilised in 2Q, further acceleration currently looks unlikely, and downside risks prevail.
Domestic demand, consumption in particular, was a reliable growth driver in Switzerland over recent years, and we do not expect this to change much going forward. Negative inflation rates and only gradually downward trending nominal wage growth mean Swiss consumers continue to benefit from relatively robust real income growth.
Meanwhile, the global environment will add to the FX challenges of the Swiss tradable goods sector. The Euro area continues to be the main market for Swiss exporters, and manufacturing weakness in Germany, in particular, could become a little more burdensome for Swiss exporters. Industrial orders on hand continued to decline at a pace of 5.1% yoy in 3Q, suggesting that industrial production is likely to remain weak over at least another quarter, too.
We, therefore, expect Swiss growth to continue to wobble around current growth for at least another half year. Annual GDP growth of 0.9% this year is likely to be followed by another unspectacular 1.1% growth in 2016 before recovering to 1.5% in 2017.
Inflation getting stuck below zero as second round effects unfold
The inflation outlook is somewhat more worrying, as second round effects from the sharp currency appreciation and the oil price effect start to unfold. Headline inflation stood at -1.4% yoy in October, on track for an annual average of -1.2% this year.
Energy related base effects will start to fade over coming month, but the effect on headline inflation will be much smaller than elsewhere due to the sharp exchange rate appreciation. Core price inflation, at -0.7% yoy in October, is likely to be stuck at these levels for some time before gradually improving again in 2Q next year, when the exchange rate effect will slowly start to fade.
While we expect headline inflation to reach zero again by the end of 2016 (we forecast – 0.4% for 2016 and 0.1% for 2017), core inflation is likely to remain stuck slightly below zero in 2017, too.
We note with concern that Swiss services price inflation hit 0% in October and broader domestic goods and services fell to -0.1% yoy, lowest on record. Combined with the economic weakness and pressure on the labour market, we would expect wage pressures in the Swiss economy to mute even further. Nominal wage growth slowed to 0.8% in 2014 and further to 0.7% yoy in 1H 2015. With companies cutting costs to regain competitiveness, we would expect employment growth to slow, but equally nominal wage growth to continue to trend closer to zero in 2016 as inflation expectations gradually adjust to the downside.
A larger than expected ECB deposit rate cut could could hurt
With the economy doing ok, but inflation dynamics becoming tricky, the SNB will try to fend off further tightening of domestic monetary and financial conditions through the exchange rate.
Therefore, a sizeable deposit rate cut of 40-50bp by the ECB could increase pressure on the SNB to intervene. Under such a scenario, we think the SNB would ultimately have to cut its deposit rate by an additional 25bp to -100bp, in order to offset the tightening in domestic monetary conditions through the exchange rate with a loosening through the interest rate. We cannot rule out, however, that the SNB would first attempt to smooth currency pressure through FX interventions, and cutting interest rates in a surprise move later in the month – possibly waiting for the FOMC move on 17 December.
