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SNB to keep interest rates negative

Credit Suisse publishes "Monitor Switzerland" for Q4 2019

According to Credit Suisse forecasts, predicted economic growth of 1.4% in Switzerland in 2020 is likely to be up on the figure for 2019 (revised down from 1.1% to 0.9%), but this rise is overstated due to the effect of major sporting events. Nevertheless, the capital goods industry should stabilize. Detailed analysis of the SNB's negative interest rate policy by Credit Suisse economists indicates that this monetary policy instrument helps prevent an even greater overvaluation of the Swiss franc against the euro and will likely be retained as long as Switzerland’s major trading partners face challenges growing their own economies.

Credit Suisse economists are predicting a slight acceleration in the growth of gross domestic product (GDP) in 2020. However, this figure is overstated by around 0.3 percentage points due to the Summer Olympics and the European Football Championship, because the licensing revenues of the international sports federations based in Switzerland (IOC and UEFA) are included in GDP, even though the activities take place outside Switzerland. Following the downturn in 2019, output from the local capital goods industry should stabilize in 2020. This is indicated by the Purchasing Managers Index (PMI) for Swiss industry compiled by Credit Suisse in cooperation with procure.ch. Economic growth will continue to be driven by private consumption, as the labor market situation should remain fairly robust.

Negative interest rates in Switzerland are the result of global trends
As the economists at Credit Suisse point out in an in-depth analysis of the Swiss National Bank's negative interest rate policy, the trend toward declining interest rates is a global phenomenon that has persisted for decades. This trend can be attributed on the one hand to falling inflation – and therefore to successful central bank policy focused on monetary stability worldwide – and on the other hand to lower real interest rates. These are the result of a number of factors including demographic ageing, lower productivity growth, a high propensity to save due in some cases to cyclical factors, and relatively low investment demand. The central banks of major currency zones, such as the US Federal Reserve (Fed) and the European Central Bank (ECB), have only a temporary influence on this real component of interest rates.

The SNB has limited scope for setting interest rates
The SNB's influence on long-term interest rates (bonds) in Switzerland is negligible; according to Credit Suisse economists, the influence of interest rates outside Switzerland is the dominant factor. "In addition, the SNB is confronted with the so-called monetary policy trilemma" says Oliver Adler, Chief Economist Switzerland at Credit Suisse: "It must choose between controlling key interest rates and the exchange rate, unless, of course, it intends – as the third option – to prevent capital movements between Switzerland and other countries. This option would be disastrous for the Swiss economy and the financial center."

Since the start of the financial crisis, strong revaluation of the Swiss franc has repeatedly posed a threat to economic development and price stability in Switzerland. In order to stabilize the exchange rate following the abandonment of the EUR/CHF floor, the SNB cut interest rates at the beginning of 2015 to below those in the euro zone, i.e. into negative territory. While the relationship between the interest rate differential and the exchange rate is not obvious at first glance, empirical analysis shows that the widening of the interest rate differential to the euro zone continues to lead to a weakening of the Swiss franc.

Negative interest rates to persist for the foreseeable future
According to estimates by Credit Suisse economists, the Swiss franc is currently overvalued by about 10% against the euro (EUR/CHF fair value: 1.22). For many export sectors, this figure is even higher. At the same time, there are few signs that the SNB's current monetary policy is too expansionary. Inflation is at the lower end of the target range, economic growth is subdued, and the yield curve is neutral. Only the so-called credit gap (i.e. the difference between trends in credit growth and economic growth) points to a more relaxed monetary policy. Nonetheless, a tightening of monetary policy does not seem appropriate yet. In particular, any autonomous increase in key interest rates by the SNB could lead to a sharp appreciation of the Swiss franc and cause considerable damage to exporters and the economy as a whole. Moreover, any move of this kind would tend to depress inflation expectations and therefore long-term interest rates. The economists at Credit Suisse therefore do not regard exiting the current monetary policy regime as a meaningful option until interest rates on the international capital markets rise and the ECB, in particular, raises interest rates. This would probably only be the case if global growth or inflation were to pick up significantly. Neither of these seems likely for some time to come.

Winners and losers from low/negative interest rates
Credit Suisse economists identify the state and taxpayers as the beneficiaries of low interest rates. They estimate that between 2008 and 2017 the Confederation and the cantons saved a total of around CHF 23 billion in interest, of which the Confederation alone saved CHF 13 billion. By contrast, the overall impact of falling interest rates on private households is not clear. On the one hand, interest rates on debt – and mortgages in particular – are falling; on the other hand, private households have had to accept reduced income from savings accounts and bonds. Credit Suisse economists estimate that these two factors are currently more or less in balance, with households with higher incomes, higher borrowing capacity, and higher risk-taking capacity tending to benefit most from low interest rates.

The SNB's negative interest rate policy directly impacts the liquidity pension funds hold (around 5% of assets). Indirectly, all factors contributing to the current low bond yield environment, including the SNB’s negative rates policy, reinforce the main problem faced by pension funds: that conversion rates are too high and the retirement age too low.

The greatest risks associated with low interest rates lie in the real estate market, in misallocation of capital, and in rising debt. While institutional investors in particular have built a large number of rental apartments in recent years and vacancy rates continue to rise, construction volumes have not risen excessively compared with GDP since the financial crisis. However, real estate prices, particularly for condominiums, have risen much more sharply than the consumer or rental price index since 2008. The primary cause of this development is probably the decline in mortgage interest rates, which has led to a sharp rise in household debt and hence the demand for residential property. Here too, the influence of long-term interest rates has been dominant. The sharp rise in household debt and real estate prices represents a potential stability risk for Switzerland.

The exact costs incurred by the banks as a result of the SNB's negative interest rate policy are difficult to quantify. So far, banks have been reluctant to apply negative interest rates to customer deposits and lending rates. Information provided by various domestic banks thus produces a mixed picture of the effect of interest rate changes. For example, there is no evidence that negative interest rates have had an adverse effect on bank lending. However, if banks more broadly pass on negative interest rates to their customers, this could result in a deeper negative impact.

Credit Suisse economists have also calculated the gains that can be expected from the SNB's sharply increased foreign exchange reserves. According to the study, annual revenues of CHF 18 to 20 billion can be expected over the next five years; in the worst-case scenario, however, there is a potential loss of CHF 75 billion. Nonetheless, an increase in the annual distribution of profits to the Confederation and the cantons could certainly be considered.  

"Monitor Switzerland" is published quarterly and is available online in English, German, and French at: www.credit-suisse.com/monitorswitzerland

The next issue will be published on March 17, 2020.