In language and forecasts, a dovish Swiss turn

The latest Swiss National Bank meeting was somewhat dovish, but in line with expectations, including language changes in the bank’s statement, its approach to the currency and softer inflation forecasts. We analyse what stood out for fixed-income investors.

Peak Swiss rates raise questions of cut timing

The Swiss National Bank (SNB) left interest rates unchanged at its December policy meeting but adopted more dovish language in its statement as it lowered its forecast outlook for inflation. The simultaneous weakening of Swiss growth and stronger than expected decline in domestic inflation likely signalled to the SNB that it has tightened interest rates sufficiently thus far.

Swiss rates are effectively now at their peak at 1.75%, making the key question when the bank can move lower. Going forward, it appears to be adopting a watchful stance, taking cues from the data and acting accordingly. It highlighted the decrease in inflation over the past quarter while also flagging high levels of uncertainty and a need to monitor developments.

This focus on uncertainty differs from the Federal Reserve, which at its December meeting did not push back on dovish market expectations and instead pointed to softer labour data as potentially justifying loosening next year. The Fed has found confidence in US data, and even if the SNB mandate does not include employment, the Swiss central bank could easily follow the overall dovish trajectory in the next few months, and could even cut sooner.

Notably, the SNB statement dropped previous language on possible future hikes not being ruled out. Instead “The SNB will… continue to monitor the development of inflation closely, and will adjust its monetary policy if necessary to ensure inflation remains within the range consistent with price stability over the medium term.”

To us, the change in language signalled the central bank: (a) being data dependent and (b) adopting a more one-sided and dovish message.

Reducing the forecast inflation path

The downward revision to the bank’s conditional inflation forecasts (figure 1) was another sign that policy loosening could be in the cards next year. The 2025 end-point of the forecast horizon was particularly relevant: the SNB lowered its forecast from 1.9% to 1.6%, thus implying a possible first interest rate cut next year since the forecast is well below its 2% target.

The move to a 1.6% forecast by end-December 2025 offers the bank greater flexibility on when to loosen policy as it can pick any meeting next year, in our opinion.

Figure 1. Swiss inflation and SNB inflation forecast

Source: BES, SNB and Bloomberg. For illustrative purposes only. As at 18 December 2023.

The currency: a change in tack

The SNB could now turn to reducing the balance sheet: it ballooned from currency interventions to weaken the Swiss franc during the ultra-loose policy of the last decades but is now contracting. In recent quarters, the SNB has reduced it by around 3% to 4% per quarter, so it will be several years before normalisation is complete (figure 2).

Figure 2. SNB FX transactions and balance sheet size

Source: SNB, Bloomberg. For illustrative purposes only. As at 18 December 2023.

Generally, the currency plays an important role for Swiss policy, far more than for other major central banks. So far, the franc has not appreciated too much in real terms and could soften as a corollary of lower interest rates, if required.

Interestingly, the latest policy statement also changed the language on foreign exchange. Previously the SNB’s explicit focus was on selling foreign currency, whereas that bias has since disappeared with lower inflation prints and a stronger franc. Now, the policy statement says “The SNB is also willing to be active in the foreign exchange market as necessary.”

Going forward, we note that the bank’s sensitivity to currency moves are likely to colour its decisions on rates. Were the currency to depreciate too strongly from here, then the SNB could ease policy again, most notably through lowering interest rates. This scenario cannot be completely ruled out, in our opinion.

Where to next?

We believe that the market’s expectation of a first SNB rate cut in March 2024 seems a little early, especially because we do not expect a severe recession, but merely a slowdown in growth. Rather we expect the first SNB reduction later in the year.

The recent Fed meeting increased the chances of a soft landing scenario, but the spectre of a no landing scenario remains. In this context, we see the SNB remaining in ‘wait and see’ mode and assessing the data for when to loosen policy.

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