global perspectives
What do the franc and property say about the Swiss economy?
There is greater ambiguity about the global economy amid a tussle between inflation, growth and the budding removal of monetary stimulus. As a small, open and export-dependent economy, Switzerland has always been guided by both the global context as well as domestic drivers.
Where could the Swiss economy head next and how are the key channels of foreign exchange and real estate important for policy?
Global dynamics: inflation and growth
Sharp rises in US inflation have spurred a more hawkish turn from the Federal Reserve, in turn eliciting market concerns about growth. The global upswing in inflation is arising from on-going supply chain disruptions, strong post-pandemic demand and signs of wage pressures. Yet, simultaneously, investors are concerned about growth waning due to central banks removing accommodation too soon and too decisively, thereby prematurely braking economic activity.
Cue the recent flattening of the US Treasury yield curve, signalling rates rising in the short term as central banks tackle inflation, while lower long-term rates reflect expectations of a slowdown or even a recession. Simultaneously, some trans-Atlantic divergence has arisen between the nascent removal of US stimulus while the European Central Bank (ECB) steers clear of potentially “premature” policy tightening.
We note that the global economy has become more closely linked with financial markets and that higher levels of debt heighten the sensitivity to interest rate rises. This means potential rate rises, even in small increments or expectations thereof, risk making a more meaningful impact on markets and the economy.
The key question is increasingly: will growth prove persistent? We see the global short-term forecasts for growth holding true, but highlight that growth will only endure if there is a durable increase in borrowing or greater capital expenditure by companies or governments. Currently, consumers are still spending savings they accumulated during the pandemic. Whether such spending reflects a one-off, short-term effect or more of a lasting behavioural shift remains to be seen. Secondly, companies are orienting capex to returning cash to investors – this fails to galvanise growth as much as investing in back into the economy.
Swiss economy rebounds
The Swiss economy has enjoyed a strong rebound as evidenced by firm indicators of economic activity. The economy grew by 1.8% QoQ in Q2, for instance and the Swiss National Bank (SNB) continues to expect a GDP figure of around 3% for 20211, closing the gap to pre-COVID levels in the second half. And confidence is strong, signalled by indicators such as the KOF business confidence and the PMI sentiment surveys, which remain firm and above long-term averages, even if they are below the year’s peaks.
Notably, Swiss PMI has outpaced growth in the major economic zones (as well as trading partners), as shown in figure 1.
Figure 1. PMI comparison
Source: LOIM, Bloomberg. Refers to 3-month average of the Purchasing Managers Index (PMI).
The SNB generally expects solid growth momentum to continue in the coming quarters, and remains willing to intervene in the foreign exchange market as necessary, in order to counter upward pressure on the highly valued Swiss franc and attempt to keep exports competitive. Intervention on foreign exchange markets has been a key pillar of the SNB’s ultra-accommodative policy as it seeks to crimp the strong franc, making exports uncompetitive.
We now expect the currency’s role as a growth channel to come into focus.
Currency and real estate matters
We are keeping an eye on two relevant undercurrents in the Swiss market: the currency and real estate. The pressure to label the Swiss franc as “highly valued” has diminished, in our opinion. Despite recent broad-based EUR weakness, some currency models are showing smaller deviations from fair value and currency interventions are not thought to be necessarily pronounced.
Given the decent rebound in economic activity, could the bank consider letting the currency appreciate on a relative basis in order to gently moderate growth? This would offer more time for the outlook in the Eurozone to improve, leaving the ECB to lead on policy changes and giving the SNB breathing space before it needs to begin unwinding its ultra-expansive policy.
Sustained demand for housing has driven concerns about more persistent inflation globally, and is also evident in Switzerland. The SNB has warned that mortgage lending and residential property prices have risen strongly in recent quarters, highlighting the increased “vulnerability” of the mortgage and real estate markets.
The SNB uses the countercyclical capital buffer to prevent banks from excess real estate lending, and as a lever to slow down the housing market. The buffer, requiring banks to hold additional capital for residential mortgage loans, was deactivated at the beginning of the pandemic in order to stimulate lending. The SNB regularly reassesses the need to request the buffer be reactivated.
The 2020 removal of the buffer helped support the recovery, but it also failed to prevent a surge in house prices, in our opinion. With bank balance sheets currently strong, we expect the SNB to request that the buffer be reinstated, especially as the pressure on housing has persisted for some time. This would be an adept way for the SNB to tame one potential source of persistent inflation.
Conclusion
The monetary status quo may hold in the very short term yet uncertainty has clearly increased about the outlook for inflation and growth, leading to a greater dispersion of possible outcomes. COVID cases are on the rise once more in Europe, further clouding the outlook. This uncertain context should continue to nurture ambiguity and possibly even widen the discrepancies between scenarios, especially as the persistent vs transitory debate continues to play out. The SNB’s ability to intervene in foreign exchange markets has proved a powerful tool to pilot the Swiss economy through global turbulence, and will likely continue providing optionality and flexibility for policymakers going forward.
Sources.
1 Source: SNB September monetary policy assessment (Monetary policy assessment of 23 September 2021 (snb.ch) ).
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