Swiss hold policy line after franc shock risking deflation

[ZURICH] Swiss National Bank President Thomas Jordan may have decided that one cataclysmic market shock is enough for now.

Jordan and his fellow central bankers in Zurich are assessing the economy and worsened prospects for inflation since a policy change three months ago that shocked markets and sent the franc surging against the euro.

With the currency bearing down on inflation and the outlook for growth, the International Monetary Fund recommends the SNB implement more stimulus.

While data this week will probably show consumer prices plunged the most in almost three years in March - justifying further action - Jordan is likely to conserve his remaining ammunition in case the Greek debt crisis flares further or the risk of a Swiss recession mounts.

"The SNB doesn't have that many policy options," said Maxime Botteron, economist at Credit Suisse Group AG in Zurich.

"To cut rates further, the SNB would need a very good reason."

The SNB expects consumer prices drop to 1.1 per cent this year - the most in six decades and marking a huge deviation from the central bank's price-stability definition of an inflation rate below 2 per cent.

That dismal outlook follows Jordan's unexpected Jan 15 announcement that the SNB was scrapping its 1.20-per-euro franc cap. To dissuade investors from holding franc-denominated assets, the SNB also cut its deposit rate to a record-low minus 0.75 per cent to compensate for the loss of the minimum exchange rate.

In addition to the IMF recommendation that the SNB could provide more stimulus by buying foreign assets, there has also been a more intense domestic political focus on the central bank.

With the policy change exposing the economy to a greater price pressure and higher unemployment, the government has discussed what options the SNB has at its disposal.

Finance Minister Eveline Widmer-Schlumpf had to deny the government was unduly trying to exert pressure after a March 4 newspaper report said that some ministers wanted the ceiling on the franc re-introduced.

Fifty-six per cent of voters support the SNB's exit from the minimum exchange rate, according to a poll by gfs.bern for Swiss broadcaster SRF published last week.

"I don't expect the SNB to do much - I expect the exchange rate to stabilize at its current levels, or with a slightly weaker franc," said Martin Gueth, an economist at LBBW in Stuttgart. If the SNB were to cut the deposit rate further,

"I'd expect them to announce measures in tandem to make sure there's not a flight into cash," he said.

Exchange-rate developments would speak for further easing. The franc climbed to a two-month high against the euro on April 2, with the common currency hobbled by Greece's struggle to secure bailout funds and avert a default.

Switzerland's blue-chip equities have recovered from the record slump following the decision to give up the cap, though the SMI Index still lags behind the Stoxx Europe 600 this year.

Although Mr Jordan indicated in early February there was room for a further cut in the deposit rate, he told Bloomberg Television on March 19 that the SNB had already gone "very far" with a deposit rate of minus 0.75 per cent.

"We have now to see what is the impact," he said.

Sight deposits of domestic banks - the cash commercial banks hold with the SNB - declined in the week ending April 3 to 377.4 billion francs, a sign the SNB hasn't waged interventions. Sight deposits rose late last year as the central bank sought to defend its cap on the franc.

According to Alexander Koch, an economist at Raiffeisen Schweiz in Zurich, Mr Jordan's next move depends greatly on events beyond Switzerland's borders.

If the interest-rate differential "diminishes again, especially with Greece or other geopolitical risks," then further policy easing isn't ruled out, he said.

While Mr Jordan and the policy makers on the SNB's Governing Board repeatedly describe the franc as overvalued, and have threatened further interventions to weaken it, they've also stated they don't expect a deflationary spiral of falling prices and consumers postponing spending. That view, that this slump will be short lived, speaks against more action.

"They're interesting proposals that we're looking at," Governing Board Member Fritz Zurbruegg said of the IMF's suggestions. "It's the role of an independent assessor to make proposals. And I think that's about it."

BLOOMBERG

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