Swiss inflation target signals more tightening

Following the Swiss National Bank’s latest monetary policy meeting, we  consider the inflation backdrop in Switzerland and explore factors that argued against a larger hike. 

 

Need to know The Swiss National Bank slowed the pace of its policy tightening and left its inflation forecast above the 2% target, signalling more rate rises ahead A current snapshot of price rises shows decisive falls in CPI across several gauges Expectations of a dovish 50bps hike were not realised – we consider why

 

A 25bps hike but inflation target stays firm

Joining the chorus of central banks fighting inflation, the Swiss National Bank (SNB) continued to tighten monetary policy by raising its key interest rate by 25 bps at its latest June meeting and not ruling out additional rises. The 25bps increase was smaller than previous, chunky, rate hikes and kept the bank’s options open for the next assessment in September, when we expect more policy tightening.

Alongside the 25bps rise, the SNB adjusted its conditional inflation forecast, which is central to the bank’s future actions. At the March meeting, the forecast was already entirely above the SNB's own 2% inflation target for the entire observation period until Q4 2025. This was a relatively clear signal that the bank was not on course to meet its target, making the June rate increase somewhat foreseeable. Now, in June, the end point for the forecast of Q1 2026 is 2.1% and remains above the SNB's target – a similarly hawkish message.

The SNB is thus signalling through its forecast that further tightening will be necessary. This echoes the projection of the European Central Bank (ECB) at its June meeting, when it also revised its forecasts upwards and said another hike in the eurozone in July was highly likely.

 

Inflation falling

While inflation is still above the SNB’s target in future, a current snapshot of price rises shows them coming off decisively from the peak in March (figure 1). Inflation has eased on several gauges such as core, headline and trimmed CPI, indicating some cooling.

The decline in trimmed inflation – which removes the extreme price changes on both sides of the distribution – gives the SNB greater confidence that it is moving towards meeting its inflation target because a large proportion of the basket contributing to inflation is in line with the bank’s target. This signals that inflation is not as broad-based as previously feared and removed some of the pressure for a potentially larger rate increase.

 

Figure 1. Inflation indices for Switzerland

Source: BFS and SNB. As of May 2023.

 

Why no 50 bps hike?

By delivering a hawkish 25 bps rate rise, the SNB excluded another potential choice: a dovish 50 bps rate increase, which some in the market had expected. This may reflect the bank realising that previous rate rises take time to feed into the economy, and that there is a delay in policy making an impact on the economy. As with all monetary policy, it’s difficult for central banks to know the outcome (and therefore end-point) of their policy moves before it actually occurs because of the lag in the transmission mechanism. So the SNB may have decided to hold its policy fire.

Lastly, the rise in the so-called reference rate for rents could also have come into play. On June 1, 2023, the Reference Mortgage Rate rose from 1.25% to 1.50%. It marked the first time in 15 years that this rate has increased. The reference mortgage rate is used to determine Swiss rents and is based on the weighted average interest rate for mortgages in Switzerland. Under tenancy law, landlords are in principle entitled to increase rents, though conditions apply so the transmission mechanism is not direct.

Still, some rents could increase in the Autumn, leading to rises in headline inflation that are technical and not broad-based. The SNB is expecting this adverse shock, though it is not yet in the data. And even if the reference interest rate pushes up rents in the next months, we currently see a marked cooling of inflation overall.

Elsewhere, the bank delivered a modest outlook for growth this year of an estimated 1%, even if growth in Q1 was deemed robust. As other major central banks toe the line between taming inflation without destroying growth, we believe that Switzerland is in its own distinctive situation. The country – unlike others – has been spared a recession. This gives the SNB greater leeway to take some risks in its assessment compared to other countries, and potentially even over-tighten because Swiss growth is less precarious.

 

More to come We expect the SNB to deliver another rate increase in September, at which point it will pause to wait and see the impact of its policy tightening. On average, there is a lag of several months between tighter monetary policy and the economic impact. A risk to this expectation is a potential slowdown outside of Switzerland: should recession materialise elsewhere it could impact the Swiss economy and, in turn, stall further removal of accommodation.

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