Swiss Vignette in Central Banking: ‘Plus Ca Change’ – Mike Dolan

By Mike Dolan

LONDON – The popular notion that the global economy has entered a more inflationary phase in the wake of the pandemic finds a surprising counterpoint in Switzerland, raising questions about the sustainability of changes facing central banks worldwide.

The aftermath of a global pandemic, coupled with surges in inflation, energy crises, and geopolitical tensions, marked the end of a decade defined by battles against deflation and persistent low interest rates. As a result, policymakers initiated one of the most severe tightening cycles seen in decades between 2022 and 2023.

As this tightening trend begins to reverse, numerous economists speculate that the new landscape—characterized by de-globalization, protectionism, energy transitions, and elevated public debt—will likely correspond with higher inflation and interest rates than those witnessed in the previous decade.

However, the Swiss National Bank (SNB) appears to be charting a different course.

In March, the SNB became the first major central bank to lower interest rates, and this week it returned to what it deems a "neutral" policy rate of just 1%, signaling further cuts in the pipeline. It’s plausible that the SNB could approach zero or even negative rates again within a year.

Contrary to expectations of high inflation, Switzerland’s current inflation rate has diminished to just 1.1%, remaining within the 0-2% target range for over a year. Notably, the central bank has recently revised next year’s inflation forecast downward to just 0.6%.

Switzerland, known for its small and open economy, faces unique challenges, including a persistently overvalued currency that tends to attract "safe haven" demand during geopolitical tensions.

The ongoing strength of the Swiss franc, which recently reached its highest point against the euro in nine years, poses challenges for exporters and contributes to subdued pricing pressure. As the currency remains central to SNB policy, the central bank may find itself revisiting its approach to quantitative easing—exchanging francs for foreign currencies.

At the peak of its previous efforts to curb the franc’s appreciation, the SNB’s foreign currency balance sheet had ballooned to over 1 trillion francs, which accounted for about 125% of Swiss GDP. Although the SNB has reduced its balance sheet by approximately 200 billion francs since the return of inflation and rising interest rates, it may soon be forced back into similar tactics.

Some financial institutions, including UBS, believe the SNB’s easing moves may be nearing their limit, arguing that its initial cuts were sufficient and that further reductions will be minimal. However, with the European Central Bank and the Federal Reserve beginning their own rate cuts, risks to the franc may tilt unfavorably, particularly as global disinflation trends continue to intensify.

Amid various geopolitical uncertainties, including the upcoming U.S. general election, the SNB faces considerable challenges in managing the franc’s volatility.

The situation in Switzerland offers an intriguing perspective, as the SNB’s experiences echo a broader trend seen in other major economies, such as the eurozone and Japan, which also struggled with zero and negative interest rates prior to the pandemic. The structural and demographic challenges faced by these larger economies invite scrutiny over whether any substantial changes have occurred since the pandemic that would affect demand, pricing, and interest rates going forward.

The European Central Bank seems to have largely addressed its inflation obstacles, as market indicators suggest it may not meet its 2% target in the near future. Meanwhile, the Bank of Japan is only beginning to adjust after a prolonged period of deflation and ultra-low rates. If price pressures again subside, that normalization process could face further restrictions.

China, grappling with significant issues stemming from its property market downturn and a lingering deflationary environment, is also rapidly easing its monetary policy, potentially leading it toward a low-rate future similar to that seen before.

While the U.S. may find itself in a different economic situation, even top officials at the Federal Reserve have contemplated the possibility of falling short of its inflation target as it seeks a balanced policy stance.

In summary, as the global landscape shifts, it seems some fundamental challenges remain unchanged.

The views expressed are those of the author, a columnist for Reuters.