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SNB faces deflation challenge as Swiss prices plunge

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Just around the corner from the Swiss National Bank's Zurich headquarters, officials can see their currency policy taking effect.

[ZURICH] Just around the corner from the Swiss National Bank's Zurich headquarters, officials can see their currency policy taking effect.

The windows of Bongenie-Grieder, an upscale clothing store on the city's Paradeplatz, are advertising price cuts of as much as 20 per cent on brands such as Burberry, Versace and Armani because of the strength of the franc. While such discounts might offer a boon to shoppers, they also underscore the challenge central-bank officials now face in stoking consumer-price growth.

The shopping-street impact of the SNB decision to abandon its 1.20 per euro ceiling last month is spreading across Switzerland, cheapening the cost of imported goods from cars to groceries. That's threatening to deepen a drop in the inflation rate, which officials expected to remain below zero this year even before they abandoned the cap on Jan. 15.

"If the franc doesn't budge from its current level of about 1.05 per euro, we should clearly have negative inflation," said David Marmet, an economist at Zuercher Kantonalbank in Zurich. "Some stores have already lowered prices, and some have yet to do so. That'll have an effect on price growth." Consumer prices extended their slide in January, dropping an annual 0.5 per cent, the federal statistics office in Neuchatel said on Tuesday. While that's less than the 0.6 percent decline forecast by economists in a Bloomberg survey, it's the biggest drop since May 2013. The country's jobless rate, adjusted for seasonal swings, stayed at 3.1 per cent in January, the statistics office also said.

Switzerland has already experienced annual consumer-price declines for the last three years. The country doesn't produce cars and, in addition to them, imports many everyday items such as food, clothing and toiletries. The euro area is Switzerland's biggest trading partner.

The franc, which traded at 1.0477 per euro at 1:46 pm in Zurich, has appreciated some 15 per cent since the SNB dropped the minimum exchange rate last month. That means shopping abroad - just a few hours drive from anywhere in Switzerland - has become more tempting, making shop owners adopt radical measures to retain customers.

Swiss supermarkets Migros and Coop have reduced prices on imported items from the euro zone some 10 per cent, while Daimler AG is giving a rebate of 18 per cent for Mercedes and Smart autos. Rival car-dealership amag, which offers brands including Volkswagen, Audi, Porsche and Skoda, is also allowing a 15 per cent currency discount.

"We're meeting the expectations of our customers," Roswitha Brunner, a spokeswoman for amag, said via e-mail. "The market expects an offsetting of the currency effect following such a drastic decline in the euro." Having lifted its cap on the franc, the SNB, whose mandate is a positive inflation rate below 2 per cent, has yet to issue new forecasts. Its previous view, issued in December when the minimum exchange rate was still in place, was for a 0.1 per cent decline in 2015. SNB Vice President Jean-Pierre Danthine said in an interview with the newspaper Tages-Anzeiger late last month that the price declines would be "temporary." Should the slump in price growth prove enduring, consumers' outlook for prices could be hit and they could cut spending, threatening the Swiss economy.

So far, household spending and domestic demand have underpinned growth. That helped the Swiss economy outperform the euro area every quarter since 2012 even as manufacturing and tourism battled an unfavorable exchange rate.

"The deflation discussion has been very key also for the SNB's policy," said Roland Klaeger, an economist at Raiffeisen Schweiz in Zurich. "But in the sense that there would be a deflationary spiral in Switzerland, with demand collapsing, as there has been in some European countries, I don't see that." The Swiss government says it's still too early to say how much growth will slow and prices fall due to the exchange-rate shock. It will publish new forecasts on March 19, the same day the SNB is scheduled to announce its next monetary-policy decision.