Swiss Economy Very Exposed to Euroland’s Problems

December 15, 2011

The Swissie rose against the euro today when Swiss National Bank officials did not change the currency’s minimum exchange rate of 1.2 per euro following a scheduled quarterly review of monetary policy.  In a released statement, however, central bank officials re-promised to spare no effort enforcing the exchange policy introduced September 6, and they predicted a depreciating franc over time.  Such a development indeed is assumed in new inflation forecasts along with an assumption that the 3-month Libor point and range targets are kept at zero and 0-0.25%, respectively.  In spite of this loose credit policy, the CPI trajectory was again revised downward, although not so sharply as the revisions made in September.  Under the new forecast, inflation bottoms at negative 0.8% next quarter.  On-year inflation in 1Q12 was projected in the June review at 1.0% and in the September review at minus 0.4%.  Inflation is now not expected to exceed zero until 4Q12.  Inflation is projected to average minus 0.3% in 2012 and +0.4% in 2013, and even in the third quarter of 2014, it is projected to be no more than 0.8% higher than in the year-earlier quarter

The SNB view has been radically transformed from a year ago, and the agent of change and remaining future threat is unexpectedly sharp Swiss franc appreciation.  This development already is impeding Swiss growth, which slowed abruptly in 3Q. Officials now forecast that growth in 2012 will be just 0.5% under favorable assumptions.  In the December 2010 policy review, Swiss monetary officials had anticipated inflation exceeding 2.1% by the third quarter of 2013.  Today’s review speaks of new deflationary risks if the sovereign debt and banking crisis in the euro area isn’t contained, and there is considerable concern that the problem may instead intensify.

A further escalation of the European sovereign debt crisis cannot be ruled out. This would have grave consequences for the international financial system. Moreover, given our country’s close relations with the euro area, Switzerland’s economic prospects are highly dependent on how the crisis develops.

Switzerland’s monetary review does not quantify a worst case scenario.  Suffice it to say, the baseline estimates assume an unlikely containment of Euroland’s problems.  A true expected value incorporating the significant chance that Euroland dissolves is bleaker than Swiss officials dare to hypothesize in public.

Finally, here’s a little background on the evolution of the SNB’s policy stance.  In six moves from October 2008 to March 2009, the Libor point target was cut from 2.75% to 0.25%.  Before the first easing, it took 1.558 francs to purchase a euro and 1.138 to buy a dollar.  In August of this year, the interest rate target was cut to zero and enforced through a series of increases in Swiss sight deposits.  After spiking as high as 1.0075 per euro, the franc’s pegged ceiling of 1.20000 against the common currency was launched in early September. 

Copyright 2011, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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