Central Bank Views

Weak CHF Fails to Lift Sentiment, SNB to Keep Policy Easier for Longer

Typography

Recent weakness in Swiss franc against the euro has not yet boosted Switzerland's economic outlook in a meaningful way, evidenced by the disappointing KOF indicator and Credit Suisse (formerly conducted by ZEW) investor sentiment index for August. While, at the meeting on September 14, the SNB would certainly affirm the stance that the franc remains "overvalued" and the pledge the combat deflation, we are concerned that there would still be a long way to go for the country's economy to get back in shape, as the pass-through of exchange rate into inflation is subdued. Meanwhile, a recent study by the SNB suggests that its monetary policy would have to stay relatively more accommodative (than ECB's) for longer to push inflation higher. We believe this reinstates the central bank's commitment to leave the policy unchanged.

Economic and Investor Sentiment Fell

The KOF indicator surprisingly fell to 104.1 in August from an upwardly revised 108 a month ago. This came in weaker than 107. As the accompanying statement noted, the reading points to "a continuation of growth with rates above average, but no further acceleration should be expected". The disappointment was mainly driven by "more pessimistic assessment of the domestic firms' competitiveness", despite the recent depreciation of the Swiss franc. On a separate note, the Credit Suisse investor sentiment index fell -9.7 points to 25 in August. July retail sales and August manufacturing PMI data would be due Friday, while the 2Q17 GDP growth and the August inflation reports would be released on September 5. However, we believe the dataflow would unlikely deviate from the big picture of lackluster growth.

SNB to Keep Swiss Franc Weak

EURCHF will probably record modest pullback in August, after soaring +4.54% in July. While in consolidation over the past weeks, EURCHF has remained firm after rallying to 1.1537, the highest since SNB scrapped the 1.2 EURCHF floor in January 2015, on August 4. However, recent rise in safe-haven demand and broad-based weakness in US dollar have sent USDCHF to the lowest in 2 years, erasing all franc's depreciation against the greenback from mid-July to early-August. We believe the SNB is more tolerable over franc's strength against USD. Indeed, the mild increase in sight deposit over the past weeks has also signaled limited SNB intervention.

Certainly, SNB would prefer to see the franc to weaken further against the euro. Therefore, it would unlikely alter the monetary stance at the policy meeting on September 14, a week after the ECB meeting.

Accommodative Monetary Policy would Stay for Long Period of Time

SNB's major concern of Swiss economy is weak inflation. However, the central bank's working papers have revealed that the pass-through of exchange rate into Swiss inflation (i.e. weak currency of a country would eventually boost inflation) is very subdued (https://www.snb.ch/n/mmr/reference/economic_studies_2007_04/source/economic_studies_2007_04.n.pdf). In a recent working paper (https://www.snb.ch/n/mmr/reference/working_paper_2017_07/source/working_paper_2017_07.n.pdf), the SNB even suggests that, if ECB adjusts its monetary policy in response to a positive shock that drives up Eurozone inflation, SNB should maintain a relatively "less restrictive" monetary policy than the ECB. The paper noted that "as a result of the change in the relative monetary policy stance, the Swiss franc depreciates and inflation picks up even somewhat more than in the Eurozone". It suggests that the pass-through would be higher if SNB maintains a more accommodative monetary policy than the ECB for longer. We believe these findings reinstate the central bank's commitment to leave the policy unchanged for some time.