fixed income
SNB surprises in more ways than a rate hike
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SNB surprises on rates and more
In its most surprising policy meeting in years, the Swiss National Bank (SNB) last Thursday delivered a chunky rate rise, massively increased its outlook for inflation and gave important clues about future balance-sheet reduction measures and the sequencing of its monetary policy.
The central bank delivered a greater-than-forecast hike of 50bps, taking rates up to -0.25% and noting that more rises could be needed to stabilise inflation. It no longer sees the Swiss franc as "highly valued," but will intervene in the currency market as needed.
The rate path on the way to neutral
Even with the latest tightening, the SNB policy rate remains accommodative, and it is highly likely the SNB will move closer to a more neutral rate at upcoming meetings, in our view.
In order to blunt price-rises aggressively and keep inflation expectations in check, we expect the SNB to deliver larger rate increases at first. Over time, however, the SNB should be able to tone down its response and could reduce hikes to 25bp increments, in our view.
While the neutral level for rates is notoriously imprecise, the market is pricing the long-term terminal rate close to, or even above, 2% and expecting it to climb rapidly to 1.5% in Q1 2023. We disagree, and believe that once rates are in positive territory, the bank will use the national currency to tighten financial conditions. In fact, it may suit the SNB to refrain from currency interventions, potentially letting the franc play its part relative to inflation and growth.
The balance sheet on the path to normalisation
As it takes steps towards policy normalisation, the SNB is grappling with the symbiosis between interest rates and currency intervention. It now stands ready to either buy and sell the franc as needed to support its objectives.
The change signals the first step in the bank normalising its balance sheet to more bi-lateral interventions. We also believe it shows the bank reverting to using conventional measures (rates) in the first instance to implement policy changes, and using unconventional measures (balance-sheet reduction) only afterwards. Once the SNB approaches rates seen to be more neutral, it is likely to shift its focus to shrinking the balance sheet.
We believe the SNB should try to gradually reduce its balance sheet, which should further increase the pressure on the Swiss franc and at the same time remove wind from the economy's sails. This could mean that fewer interest-rate steps will be necessary overall or that the increase will be more gradual and slower than currently expected by the markets.
Our base case scenario is a 50bps rise at the September meeting, followed by a 25bps rise in December, taking the base rate to 0.50% for year-end 2022. This outlook strongly depends on macroeconomic data, however, as the bank will likely adapt its policy relative to inflation, GDP and currency moves.
Inflation projection surges
Now more than ever, the outlook depends on data. As such, the bank’s latest round of forecasts hold more clout than ever. Indeed, the SNB’s long-term inflation forecast surged in light of the current global inflation backdrop. In March, it expected Q4 2024 inflation at 1.1%, whereas at the June meeting it now sees Q4 2024 inflation at 1.9%, and Q1 2025 inflation at 2.1%. As shown in Figure 1, this represents roughly a 100bps increase in projections.
Figure 1. Core inflation vs SNB projected inflation
Source: LOIM, SNB.
The timing of this forecast overhaul appears somewhat surprising: the SNB did not acknowledge the high-inflation drivers in its March forecasts, even though sharp rises were already being recorded, and the transitory nature of inflation had already been challenged strongly, further fuelled by an armed conflict driving energy prices higher. Instead, in March the SNB’s projection only marginally reflected these new developments and added a full 100bps to its inflation outlook in June. Such a huge change contributes to the perception that the SNB will remain somewhat unpredictable.
The SNB has now joined global central banks in the fight against inflation. Amid a quite uncertain outlook, we expect the bank to use a combination of rate rises and balance-sheet reduction to further remove policy accommodation. Exactly how that mix will be deployed is not yet precise, however, especially as the SNB is likely to keep an element of surprise in its back pocket.
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