The Swiss National Bank (SNB) is facing unexpected challenges as Switzerland’s inflation rate slows down and the Swiss franc strengthens. Recent data shows that inflation in Switzerland dropped to 1.1% year-on-year in August, below both the previous month’s rate of 1.3% and the projected 1.2%. This unexpected decrease in inflation raises concerns about the SNB’s targets for the third quarter, where a significant decline is now anticipated.
The SNB had allowed the Swiss franc to appreciate in the past to combat imported inflation. However, with inflation now falling below the target and global inflation trends receding, there is a growing worry that this strategy could negatively impact exporters and push the economy towards a deflationary cycle. Swiss exporters, in particular, are struggling to remain competitive in foreign markets due to the strength of the franc.
The nominal effective exchange rate of the Swiss franc experienced a 6% decrease from January to May but has since reversed this trend in the last quarter. This reversal has led to a peak in the real effective exchange rate, signaling a loss of international competitiveness for Switzerland. The impact of the strong Swiss franc is evident in the inflationary contributions from both domestic and imported goods.
As a response to the challenges posed by the strong Swiss franc, the SNB has already reduced the policy rate twice, from 1.75% to 1.25%, and further cuts are expected to bring it below 1%. Additionally, the SNB may increase its foreign exchange purchases to counteract the appreciation of the franc. While the bank only recently became a net buyer of foreign currency in the first quarter of 2024, there is a possibility of a significant increase in these purchases to stabilize the exchange rate.
The SNB faces a complex situation with the unexpected decline in inflation and the strengthening of the Swiss franc. By implementing a prolonged monetary easing cycle, the bank aims to support exporters and prevent the economy from entering a deflationary cycle. Expanding its foreign exchange purchases and adjusting policy rates are among the measures the SNB may take to address these challenges and ensure stable economic growth in Switzerland.