Swiss face recession threat with rate firepower seen near empty

[ZURICH] Swiss National Bank President Thomas Jordan has little interest-rate firepower left as he watches over an economy teetering on the brink of its first recession in six years.

The SNB, whose deposit rate is already at a record low of minus 0.75 per cent, is up against a slump in consumer prices and a shrinking economy after the central bank allowed the franc to float freely again six months ago. It can't cut rates much more without risking a run on cash and its limit is probably minus 1 percent, according to Bloomberg's monthly survey of economists.

"A further reduction of the deposit rate would most likely lead to higher demand for cash that the SNB would like to avoid," said Karsten Junius, chief economist at Bank J Safra Sarasin Ltd in Zurich. "The SNB has reached its effective lower bound." Jordan will lead a meeting of central bankers this week before the SNB announces its interest-rate decision on Thursday and publishes new growth and inflation projections. While no policy change is forecast, Jordan will probably warn he's ready to do more if the outlook worsens as he considers the threats from the crisis in Greece and the potential breakup of the euro area.

The SNB's new forecasts will have to take into account the economy's 0.2 per cent contraction in the three months through March, which ended 13 quarters of continuous expansion. Economists in a Bloomberg survey predict another decline in GDP this quarter, which would put the economy in its first recession since 2009.

The SNB currently sees growth of 0.9 per cent this year, half what it forecast when the ceiling on the franc of 1.20 per euro was still in place. It predicts that consumer prices will fall 1.1 per cent in 2015, with the annual inflation rate turning positive again only in 2017. The franc's 15 per cent appreciation against the euro this year is the main reason for the weak rate of inflation.

The franc may come under additional pressure if Greece's debt crisis intensifies. Fears about a splintering of the euro area in 2011 prompted the SNB to set its cap on the franc, to shield the economy from the effects of haven buying.

Any change to the SNB's deposit rate would almost certainly also mean a change to its target range for three-month Libor, currently at between minus 1.25 per cent and minus 0.25 per cent.

"It is impossible to rule out some kind of catastrophic event that leads the SNB to cut rates even further," said Timo Klein, senior economist at IHS in Frankfurt. Still, with the economic outlook for the euro area improving, "the largest likelihood lies with minus 0.75 per cent already turning out to be the lower bound," he said.

SNB officials have indicated they're not currently inclined to cut the deposit rate further and are keen to see how their policy feeds through.

"At minus 0.75 per cent we've already gone quite far and we're waiting to assess the effect," SNB's Jordan told Schweiz am Sonntag last month. "Whether we need to go lower with the negative rates depends on international developments." SNB policy makers have said that so far they have seen little evidence of cash hoarding, and that piling up cash in vaults to circumvent the negative deposit rate would have high costs.

"Another 25 basis point rate cut is possible somewhere in the third quarter of 2015 if interest rate spreads between euro and franc markets continue to decrease, which put upwards pressure on the franc," said Julien Manceaux at ING in Brussels. "In this case, the lower bound would probably be at minus 1.25 per cent."

BLOOMBERG