The SNB’s balancing act between inflation and jobs

In its final policy meeting of 2022, multiple options existed for the Swiss National Bank. We analyse the decision to raise rates to 1%, explore how the SNB is walking the line between different economic signals and consider the implications for next year’s policy.

 

Need to know An end-of-year 50bps rate rise from the SNB acknowledged the trend of easier prices while conceding that the Swiss labour market remains hot The SNB’s inflation forecasts still predict rates at 2.1% in 2025, above the bank’s 2% target We see the SNB continuing its balancing act on rates next year

 

Raising rates by 50bps at its latest monetary policy meeting, the Swiss National Bank (SNB) echoed a chorus of tightening delivered by the Federal Reserve (Fed) and European Central Bank (ECB) but chose to take the middle ground between larger (75bps) and smaller (25bps) hikes. We now expect a final rate hike of 25bp in early 2023, but could also revise this estimate given the SNB’s revisions to its inflation forecast.

Going into the meeting, we saw three potential options for the Swiss central bank: staying on track with 50bps hikes, slowing down its pace with 25bps rises or accelerating with a 75bps tightening.

Option 1: a 50bps rate increase. This scenario (and its eventual choice) presented a golden mean for the SNB, as well as a compromise that was already priced into the market. The 50bps increment acknowledged the easier inflation trend of recent months while still conceding that monetary policy needs to counter an overheated labour market and take into account decent growth. By letting a rate hike do the heavy lifting, the bank opted not to use other policy tools such as balance sheet reduction.

Option 2: a 25bps rate increase and balance sheet reduction. The SNB could have tightened by just 25bps, less than what was priced into the market, thereby giving more weight to the decline in Swiss inflation and potentially accompanying the rate move with a gradual reduction in its balance sheet. In this instance, the SNB would have been less concerned by tight labour markets and more focused on the risk of hitting the brakes too hard, as well as opting to use other (unconventional) policy levers to communicate its aversion to holding a large balance sheet.

Option 3: a 75bps rate increase. The SNB did not lack arguments to hike by 75bps in order to play ‘catch-up’ with the Fed and ECB.  The SNB is behind the US and Eurozone in terms of total hikes in 2022 because it meets only quarterly and has opted for 50bps increments instead of the 75bps delivered at times by its peers. It might have delivered a chunkier rise to equalise, although this scenario was less likely because it risked sending the wrong signal to the market: that the SNB was accelerating rate hikes too late as inflation was already easing.

 

SNB walks the line

In the end, the SNB went for the golden mean scenario. The 50bps hike walks the line between dual economic drivers: lower inflation figures and softer activity data on the one hand, with strong employment and resilient GDP on the other. Both employment and GDP figures are usually perceived as more backward-looking, however.

Inflation remains above the range the SNB equates with price stability, but the bank foresees it remaining elevated only “for the time being” and slightly lowered its forecast to mid-2023. However, the SNB also raised its medium-term forecasts due to inflationary pressures from abroad and widespread price increases. Crucially, it communicated an expected Q3 2025 end-point for inflation of 2.1%, just above its 2% target. This suggests that the SNB may feel it needs to tighten policy further and, to us, hints that a greater than 25bps rate rise may be warranted next year.

 

Figure 1. Conditional SNB inflation forecasts, December 2022

Source: SNB.

 

In general, Swiss price rises are clearly slowing (Figure 2) and even negative when looking at the last three months’ average.

 

Figure 2. Swiss CPI (3m/3m, seasonally adjusted and annualised)

Source:  Federal Statistics Office of Switzerland, LOIM calculations. As of November 2022.

 

Technical factors such as administered prices are expected to firm in Q1, but we expect the SNB to look through this given the overall trend for softer inflation.  The currency remains a key influence and the appreciation of the Swiss franc this year has helped to curb imported inflation. The SNB confirmed it has sold foreign currency in recent months to ensure appropriate monetary conditions and will also sell or buy foreign currency in the future if this is appropriate or necessary.

 

Careful navigation

Decomposing recently constructive GDP data, consumer spending has held up and has not been hit as hard as expected, while investment also remains resilient. That said, other economic activity indicators have come off and show risks to the downside. For instance, consumer confidence is very negative, while PMI and KOF¹ Swiss Economic Institute indicators are turning.

Elsewhere, downside risks to the Swiss economy could emanate from the slowdown in the Eurozone. The area’s growth outlook is challenging and as Switzerland’s main trading partner, could impact the growth channel. This backdrop warrants careful navigation by the SNB.

The labour market in Switzerland remains extremely tight with structurally low unemployment (Figure 3). A similar situation exists in the US, where inflation is now receding but strong labour markets remain the last man standing. It signals a good spot for the SNB in which the economy is slowing from a strong position, hot labour markets and tighter policy from the central bank.

That said, employment indicators are usually lagging and tend to signal a change in the economic environment rather late. As such, could the Swiss economy already be in a new regime?

 

Figure 3. Swiss unemployment rate and job vacancies

Source: State Secretariat for Economic Affairs. As of November 2022.

 

In lifting rates to 1%, the SNB nodded to both easing inflation and still-firm employment. Given the bank’s latest inflation forecasts, we are watching for signals that 25bps could be in the works next year. That said, plenty of downside risks to the economy remain, leading us to believe the SNB will need to continue its balancing act in future.

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