UBS Outlook for Switzerland: EUR/CHF drives Swiss National Bank policy

Zurich - 26 November 2015

  • The Swiss economic recovery likely to continue into the second half of the year.
  • Average unemployment will probably rise to 3.3% for this year.
  • The SNB is likely to refrain from lowering negative interest rates further. But this depends on whether the EUR/CHF exchange rate remains in the 1.07 to 1.10 comfort zone without the SNB having to intervene at a non-sustainable level.

The fear that the strong franc would reduce second-quarter GDP and trigger a slight recession in Switzerland has not materialized. Economic growth was ultimately driven by solid personal consumption, investment in capital equipment and net exports.

The UBS Chief Investment Office assumes that the slight recovery in GDP will continue into the second half of the year. Overall, UBS economists expect to see moderate growth of 1.0% this year and a slight rise next year to 1.4%.

The latest climb in the UBS consumption indicator points to continued solid growth in the coming months. Lower consumer prices resulting in higher real wages play a contributing role, but a probable rise in unemployment from last year's 3.2% to an average of 3.3% for this year, may put downward pressure on disposable income and cap personal consumption growth as a result.

Abandoning the franc's minimum exchange rate for the euro has made Switzerland less attractive as a production location. Nevertheless, investment in equipment showed a surprisingly strong rise in the second quarter. But significantly lower export prices are eating into the margins of export companies and will likely curb future investment plans. After last year's mass immigration initiative – designed to curb mass migration to Switzerland – many companies are uncertain whether there will be enough qualified employees in future. Higher wage costs create an additional burden on business competitiveness.

Little movement in interest rates and EUR/CHF over the next 12 months

Increased risk aversion worldwide and growing expectation that the European Central Bank (ECB) will extend its quantitative easing (QE) program have put downward pressure on long-term interest rates in Switzerland . If the US Federal Reserve raises rates in December as UBS economists expect, Swiss rates will probably gain ground, as a moderate rise in term premiums will push rates up. The return on 10-year Swiss government bonds is forecast to approach 0.2% in the next 12 months.

UBS sees little leeway on either side for the EUR/CHF exchange rate. The Swiss National Bank (SNB) will either intervene to prop up the rate, or the franc will weaken further of its own accord as the economy dips due to the impact of the strong currency. Conversely, the ECB's loose monetary policy should limit any upward spikes in the EUR/CHF exchange rate, which UBS economists expect to stay between 1.08 and 1.12 over the next 12 months.

The SNB unlikely to push negative interest rates lower

The latest developments of SNB sight deposits indicate the bank has barely had to intervene to any major degree in the currency markets recently, even after the ECB raised the prospect of further QE at the end of October.

"If it proves possible to maintain the EURCHF exchange rate in the 'comfort zone' of 1.07 to 1.10 without having to intervene at a non-sustainable level," comments Daniel Kalt, chief economist at UBS Switzerland, "the SNB will likely refrain from imposing even lower negative interest rates – even if the ECB extends its bond-buying program by three to six months and reduces its deposit facility rate by 10 basis points." Negative interest rates are already having undesirable side-effects on the Swiss financial and pension system.[1] The increase of thousand franc notes in circulation indicates that Swiss banknotes are being used not only as a means of payment, but to a considerable degree as a store of value. Even lower negative interest rates would increase the incentive to hoard cash.

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