Salman Ahmed, LOIM’s Global Strategist, has commented on the Swiss National Bank’s policy update this morning. He discusses the implications for the Swiss currency and the wider impact on the eurozone economy. “Given the structural issues,” he concludes, “negative interest rates are here and likely to remain in place for a considerable period of time as it becomes clear that monetary policy is failing to affect real economic outcomes, while fiscal policy remains paralysed.”
This morning the Swiss National Bank (SNB) decided to abandon its minimum exchange-rate floor policy. At the same time the SNB reduced benchmark interest rates to -75bp on sight deposits (above the exemption threshold). In addition, the target range for three-month Libor has been moved further into negative territory to between -1.25% and -0.25%, from the current range of between -0.75% and 0.25%. According to the bank’s statement, divergences in monetary policies of major currency areas has increased significantly – a trend which is expected to become even more pronounced.
This action seems to be a pre-emptive response to the now increasingly expected move in ECB policy to launch a QE programme, and that was strengthened yesterday by the European Court of Justice giving the greenlight. Further easing by the ECB would have meant an even stronger impulse for the SNB to buy euro assets leading to a significant increase in the balance sheet from an already bloated 85% of GDP. By abandoning the exchange-rate floor (rather than adjusting it), the SNB has regained its flexibility in running its monetary policy and can potentially now manage its own policy without being affected by ECB choices, at least in the short term. This also means that interest rates will have to do the heavy lifting of offsetting any ensuing appreciation pressure on the currency. In terms of real economic effects, the appreciation of the currency will hurt the Swiss economy and create renewed deflationary pressures.
SNB has said that it will take into account FX developments in monetary policy decisions, which effectively means a more opaque and relatively more flexible exchange rate management regime going forward. That said, we believe there is a clear loss of credibility from abandoning the minimum exchange rate policy at this juncture. We believe that the key implication apart from short term volatility in CHF crosses, is another boost for duration assets as short term interest rates reach into ever deeper negative territory in a number of countries. In addition, once the dust settles and decoupling in regional economies becomes more pronounced, it is possible that the CHF starts to gradually depreciate against the US dollar as steep negative interest rates in Switzerland start to have an effect. Structurally, what is more serious is the inability of the eurozone economy to respond positively to easy monetary policy developments, leading to a sense that the policy will remain easy for a prolonged period of time.
This is starting to create a sustained and what appears to be a long lasting downward pull on the long-end of the interest rate curve as well. This will be reflected in Swiss interest rates as well, where FX developments will still exert a massive influence via their impact on real economic outcomes.
Given the structural issues, negative interest rates are here and likely to remain in place for a considerable period of time as it becomes clear that monetary policy is failing to affect real economic outcomes, while fiscal policy remains paralysed.
