The Swiss Economy in 2016: One Year of Negative Interest Rates
Credit Suisse economists have slightly lowered their Swiss economic growth forecasts for 2016 (from 1.2 percent to 1 percent). The strong Swiss franc will continue to have an adverse impact on the export sector in 2016 and the domestic economy will therefore see a further slackening of growth momentum.
The winter issue of "Monitor Switzerland" considers the effects of negative interest rates nearly one year after they were announced by the Swiss National Bank (SNB). The economists take the view that negative interest rates are beginning to have the impact on CHF investors and foreign banks that the SNB intended. Using survey data, Credit Suisse economists also show that negative interest rates have only partly boosted investment by small and medium-sized enterprises (SMEs) in Switzerland. However, the severe shortage of investment opportunities caused by negative interest rates is leading to a rise in high-yield real estate investment. The economists estimate that negative interest rates are providing around CHF 1 billion of relief annually in the area of government spending but point out that they are also creating long-term risks in the funding of retirement provision that could potentially place an additional burden on the government budget.
The Swiss economy is likely to experience modest growth again next year according to Credit Suisse economists. They are forecasting growth of 1 percent for 2016, well below the long-term potential growth rate, and they predict that per capita growth may even be negative as the size of the population increases. However, continued strong immigration, the ongoing rise in purchasing power and favorable lending rates are having a stabilizing effect, with the economists therefore considering it unlikely that Switzerland will enter a recession. In view of its weak growth momentum, the Swiss economy is nevertheless vulnerable to economic shocks and would, in particular, have difficulty absorbing the impact of a further appreciation of the Swiss franc. Consequently, the SNB will be forced to continue with negative interest rates until at least the end of 2016 and may also have to push them further into negative territory.
Negative Interest Rates Bite
Negative interest rates are intended to reduce inflows into the Swiss franc – a 'safe haven' currency – and this certainly appears to be working. According to Credit Suisse economists, foreign banks in particular have reduced their Swiss franc holdings. Negative interest rates are also intended to create incentives for Swiss investors to reduce the volume of cash they hold in Swiss francs and to increase their level of foreign investment. Credit Suisse data indicates that pension funds have indeed responded by reducing their allocation to cash. They have so far mainly switched to real estate, however, with less of a focus on foreign investment. Hence, the impact that the SNB wanted to achieve through negative interest rates has not yet been fully realized. Like before, the severe shortage of investment opportunities triggered by negative interest rates appears to be significantly boosting high-yield real estate investment: In view of the high level of construction activity, Credit Suisse expects vacancy rates to increase again in the coming year. In addition, negative interest rates will continue to weaken profitability in the financial sector.
The most apparent risk posed by negative interest rates is, however, that investors will switch their bank deposits to cash. The interest rate at which this occurs – the 'effective lower bound for interest rates' – is, however, difficult to identify but has probably not yet been reached in Switzerland. Although the demand for bank notes has increased according to SNB statistics, this 'surplus' demand remains well below levels that would impair the effectiveness of negative interest rates or threaten financial stability.
Costs of Low Interest Rates for the Swiss Government Will only Become Visible in the Long Term
With gross debt of around CHF 100 billion (status: 2015), the Swiss government is clearly benefiting from the current low interest rate environment, which is providing it with around CHF 1 billion of relief annually compared to the situation at the start of the decade. However, low returns are negatively affecting the future funding of retirement provision, which is likely to place a strong additional burden on taxpayers, companies and employees. Credit Suisse economists therefore believe that the need for pension reforms seems even more pressing in the low interest rate environment.
SME Investments only Partly Boosted by Low Interest Rates
As part of their 2015 survey of SMEs, Credit Suisse economists asked SMEs in Switzerland how the low interest rate environment has so far influenced their investment activities. Only around one-third of SMEs indicated that low interest rates between 2009 and 2014 had a positive or very positive effect on their volume of investments. SME investment activities generally focused on real estate – including outside the construction sector. The impact that negative interest rates have through lending channels on SME investments in fixed assets appears to be relatively limited.
Low Interest Rates Forever?
Nominal and real interest rates have been trending downward globally for 30 years. Although a slight rise in real interest rates is foreseeable in the medium term, a reversal of the current trend – leading to significantly higher levels of interest – seems unlikely. This is due, among other things, to the fact that – for structural reasons – the savings rate will probably remain too high and the level of investment will probably remain too low. Excess savings have so far mainly stemmed from emerging economies, where higher levels of income driven by dynamic economic growth have resulted in an increased savings ratio. Credit Suisse economists believe that the formation of savings is likely to be limited somewhat by slower growth in emerging economies. However, demographic factors will continue to dampen interest rates: On the one hand, the ageing of the population does not automatically lead to a reduction in savings, since the savings ratio among pensioners may be much lower but is nevertheless still positive. On the other hand, an ageing society increases the trend toward precautionary saving and thus boosts the demand for safe asset classes. Investment activity is likely to gradually recover from the after-effects of the financial crisis. The fact that the level of investment in ageing economies will probably be lower does not mean that a reversal in the long-term trend toward falling rates of investment is to be expected. The continued strong demand for bonds due to the ongoing bond-buying programs of central banks (e.g. in Europe) but also due to increasingly strict financial regulation – which favors the purchase of 'safe' bonds by banks – mean that low interest rates are likely to persist.