Swiss National Bank Slashes Target Rate 100 Bps After Unscheduled Meeting

November 20, 2008

The Swiss National Bank cut its point target on 3-month Libor interest rate by 100 basis points to 1.0%, the center of a 0.5-1.5% range. This was the third reduction between scheduled policy assessment meetings last September and next December. The SNB holds less frequent interest rate policy meetings than most central banks. Prior reductions were announced on October 8th of 25 basis points in conjunction with other central bank cuts and November 6th in conjunction with rate cuts that day by the ECB and Bank of England. The 175-basis point sum of these three reductions in the space of six weeks returns the target rate level to that prevailing between mid-December 2005 and mid-March 2006. The last cyclical policy rate low was at 0.25% prior to mid-2004.

Today’s rate cut was twice as large as the 50-bp cut earlier this month, which in turn was twice as much as the 25-bp reduction on October 8th. This escalation in the dose of easing is mirrored by increasing alarm at growth prospects and subsiding concern about inflation expressed in the successive statements released after the three moves. On October 8th, Swiss officials said a more severe global financial crisis than assumed meant that Swiss growth in 2009 would be weaker than forecast in its September policy assessment. Weaker growth and lower oil prices in turn translates to a better inflation outlook, thus allowing monetary policy to be loosened. Officials on November 6th noted continuing deterioration in the global economic outlook and warned that 2009 Swiss growth “might even be negative.” Swiss franc appreciation was added to the list of disinflationary factors, so another 50-bp rate cut was not expected to jeopardize “the return to price stability.” Today’s statement declares that price stability is likely to be restored by the end of this year, sooner than expected. Meanwhile, an appreciably worse international economy lifts the risk of a “marked slowdown” in Swiss activity in 2009. The statement hints that more easing could be forthcoming.

Since the morning of October 8 shortly before the joint rate counts were announced, the Swiss franc has advanced 1.5% against the euro, far less than the 15.4% appreciation of the yen against the common European currency. Being low-yielding currencies, the franc and yen had been favored financing mediums for carry trades and had behaved similarly and viewed as soul mates. Not anymore. And that shift underscores a transformation in how one should interpret currency strength. In most times, a strong currency yields greater benefits than costs, as it constrains inflation, promotes capital inflows, and allows central banks to keep short-term interest rates lower than otherwise. Such was the thinking behind former U.S. Treasury Secretary Rubin’s mantra that a strong dollar in in the best interest of the United States. In sharply disinflationary times like the present, however, currency appreciation serves no constructive purpose. Central banks have the leeway to cut interest rates anyway, and increasingly uncompetitive currencies like the yen and the dollar will prolong and deepen the Japanese and U.S. recessions. Some  market analysts talk disparagingly about the ECB and SNB for allowing their currencies to underperform. But the last laugh will be on central banks that permitted their currencies to strengthen at this point in the business cycle.

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