Portfolio

SNB to hold fire, but keep finger on interest rate trigger

Date: Wednesday 17 Jun 2015

SNB to hold fire, but keep finger on interest rate trigger

Ipek OzkardeskayaMarket Analyst, London Capital Group
As the Swiss National Bank´s board prepares to meet tomorrow, markets are pricing in no change in its main rate policy rate, currently in negative territory, but futures´ prices tell a different story.

The sight deposit rate will likely be kept at -0.75%, and the three-month Libor target range at -0.25%/-1.25%.

Recent strength in the Swiss franc means the SNB must stay in the game - that simple. True, currency strength is not the sole driver behind the Swiss economy´s price and cost disadvantages vis-à-vis its Eurozone neighbours. Nonetheless, stemming the franc´s vigour is a good starting point to resolving them.

Governor Thomas Jordan has been harshly criticised for the monetary authority´s decision to pull the euro-franc floor, but he had little choice. It was the inevitable price Switzerland was going to have to pay for sitting on a comfortably cheaper Swiss franc for about 40 months.

Between a rock and the ECB

Amid the volatility, it is often overlooked that the SNB is a central bank of whom miracles are being asked in the midst of a brutal currency war. Switzerland´s GDP is twenty times smaller than the Eurozone's. Not surprisingly, fatigue has set in at the SNB after fighting off the currency pressures from the Eurozone giant surrounding it.

However, it may now be wisest not to swim too hard against the flood which Draghi's change in strategy has unleashed. So long as the European Central Bank keeps pumping massive amounts of liquidity into the system, the SNB's arms will remain tied. Stuck between the need for a cheaper franc and the political and social cost of negative rates, the Swiss National Bank has very little margin to manoeuvre.

In such a situation, forward guidance on negative rates is inevitable.

SNB primed to ease as economic recovery now in sight

Indeed, euro-swiss futures suggest the Swiss market is ready to absorb up to 25 basis points of additional easing.

Hence, the Swiss National Bank is keeping its finger on the proverbial interest rate trigger, ready to smoothen the franc's path towards parity against the euro should it become necessary. The silver lining to franc strength is that Swiss equities' sensitivity to the euro-franc has fallen significantly; the 20-day correlation between the SMI and the euro-franc is back below 20% from 80% in the aftermath of the central bank´s 15 January shock decision to lift the currency cap.

As high-margin companies adapt to the changing environment, the recovery in the Swiss economy is set to kick-off earlier than many may anticipate. The journey back to inflation, however, will certainly be longer and bumpier.

Ipek Ozkardeskaya
Market Analyst, London Capital Group

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