INFOCUS MARKET SNAPSHOT

DECEMBER 2019

Can Swiss rates go much lower?

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The Swiss National (SNB) needs to maintain its differential with the in order to restrain the franc’s appreciation. GianLuigi Mandruzzato examines how much lower can the SNB’s interest rates be cut before they adversely affect the economy.

We expect the SNB’s to remain highly If the ECB were to lower rates further, the SNB would come accommodative for a long time to come. The meeting of under increased pressure to follow suit. Since the ECB cut the Governing Board on 12 December will reassert the need interest rates last September, Swiss rates are only 0.25% to maintain negative interest rates and to intervene in the lower than in the eurozone (see Figure 3). The SNB has always foreign exchange market to prevent the strengthening of the stressed the importance of the interest rate differential Swiss franc. between and the eurozone to contain the pressure on the appreciation of the Swiss franc and thus help in The SNB policy rate is unlikely to move higher in the achieving the target (see Figure 4). Many observers foreseeable future. Inflation is negative, GDP growth is below believe that if the ECB cut rates again, the SNB would follow potential and business confidence among Swiss firms remains suit. But starting at -0.75%, how much more negative can Swiss low (see Figures 1 and 2). Although growth and inflation rates become? are expected to pick up in 2020, it is premature to expect a monetary tightening in Switzerland in the next twelve months. The answer to this question is related to the concept of the This also reflects the fact that the ECB has resumed economically effective lower bound (EELB), or reversal rate, i.e. purchases and has stressed that interest rates in the eurozone the level of interest rates below which further cuts adversely could be cut further. affect growth. It is thought this is because, below a certain

1. Swiss CPI inflation 3. Monetary policy reference rates

3.5 5.0 3.0 4.0 2.5 2.0 3.0 % 1.5 ea r, 1.0 % 2.0 0.5 ear-on-y

Y 1.0 0.0 -0.5 0.0 -1.0 -1.5 -1.0 2000 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 2001 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20

CPI CPI-core 3m Libor, SNB Reference rate, ECB

Source: SNB, Refinitiv and EFGAM calculations. Data as at 6 December 2019. Source: SNB, ECB, Refinitiv and EFGAM calculations. Data as at 6 December 2019.

2. Business confidence and GDP growth 4. Swiss franc exchange rates

71 6 0.8 180

67 5 0.9 170 63 4 1.0 160 0 59 3 1.1 150

55 2 % 1.2 140 ea r, x 51 1 % 1.3 130

Inde 47 0

ar-on-y 1.4 120 43 -1 ye

39 -2 1.5 110 Index, January 2001 = 10 35 -3 1.6 100 31 -4 1.7 90 2001 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 2001 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 Swiss PMI index PMI abroad GDP, (rhs) EUR/CHF (lh axis, inverted) CHF nominal effective exchange rate (index, rh axis) Source: SNB, Refinitiv and EFGAM calculations. Data as at 6 December 2019. Source: SNB, Refinitiv and EFGAM calculations. Data as at 6 December 2019.

2 | December 2019 CAN SWISS RATES GO MUCH LOWER?

level of negative interest rates, are no longer able to One of the reasons for the effectiveness of the SNB’s policy pass on the monetary easing to the rest of the economy and is the adoption of “tiering” that limits the adverse effects could even reduce the availability or increase the cost of of negative interest rates on the Swiss banking sector.2 The credit. With banks unwilling to cut the retail deposit rate below SNB charges a negative interest rate only on the portion of zero, an interest rate cut would not reduce the cost of funding banks’ sight deposits that exceeds an exemption threshold. for banks but would reduce the returns on their assets. As a The threshold was 20 times the minimum reserve requirement consequence, banks may raise lending rates. from January 2015 until last November when it rose to 25 as decided by the SNB at its September meeting (see Figure 7).3 Available data suggest that the SNB has not yet reached the EELB. Since the introduction of negative rates in January 2015, Thanks to the exclusion threshold, from January 2015 to customer deposits with Swiss banks have risen (see Figure 5). October 2019, negative rates were on average applied to During the same period, Swiss banks increased their lending around 30% of sight deposits with the (see Figure to the private sector (see Figure 6). This evidence is similar 8). From November, the increase in the threshold will reduce to what has been reported in the eurozone since 2014 and the share to less than 10%, equivalent to about CHF 46 billion. supports the view that the SNB’s monetary policy transmission Large banks (CHF 2.5 bn) and cantonal banks (CHF 1.2 bn) will mechanism is working even with negative interest rates.1 be almost fully exempted from the negative interest burden on

5. Customer deposits at Swiss banks 7. Ratio of banks’ sight deposits to minimum reserve requirement

2000 37 35 1800 33 31 1600 29 1400 27 Ratio

CHF billion 25 1200 23 21 1000 19 800 17 200102030405060708091011121314151617181920 2015 2016 2017 2018 2019 2020 Customer deposits in Swiss banks Big banks Other banks Source: SNB and EFGAM calculations. Credit data include all Raiffeisen Bank deposits from September 2006. Cantonal banks SNB exemption threshold Data as at 6 December 2019. Source: SNB and EFGAM calculations. Data as at 6 December 2019.

6. Swiss banks outstanding credit 8. Share of banks’ sight deposits subject to negative rates

1500 35

1400 30 1300

1200 25

1100 % 20 1000 CHF billion 900 15

800 10 700

600 5 2001 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 2015 2016 2017 2018 2019 2020 Total loans Share of Swiss banks' sight deposits subject to negative rates Source: SNB and EFGAM calculations. Credit data include all Raiffeisen Bank from September 2006. Data as at 6 December 2019. Source: SNB and EFGAM calculations. Data as at 6 December 2019.

1 See Altavilla, Burlon, Giannetti, and Holton (2019), “Is there a zero lower bound? The effects of negative policy rates on banks and firms”, Working Paper Series 2289, European Central Bank, November 2019, and Lopez, Rose and Spiegel, “Why Have Negative Nominal Interest Rates Had Such a Small Effect on Bank Performance? Cross Country Evidence”, September 2019. 2 Other reasons were the changes in the composition of assets and liabilities, albeit at the cost of greater credit risk, greater exposure to interest rate risk and a reduction in capital buffers; see Basten and Mariathasan, “How banks respond to negative interest rates: evidence from the Swiss exemption threshold”, May 2018. 3 Swiss banks are required to set aside and deposit at the SNB a minimum reserve equal to 2.5% of customer deposits.

December 2019 | 3 CAN SWISS RATES GO MUCH LOWER?

the basis of deposit data available up to September. More than How much lower the SNB’s interest rates can be cut therefore 90% of sight deposits subject to negative interest rates will be depends on the exemption threshold. The higher the held by the other banks operating in Switzerland. threshold, the lower the EELB rate can be. It is interesting to note that the SNB said it will review and adjust the mechanism Overall, the SNB’s exclusion mechanism has been effective for calculating the exemption threshold to “ensure room for in limiting the adverse consequences of the negative interest manoeuvre in monetary policy going forward”. The recent rate policy on the Swiss banking sector.4 Together with the increase in the threshold and the consequent sharp reduction SNB’s activism in the foreign exchange market, the negative in sight deposits subject to negative rates supports the view interest rate policy limited capital flows into the Swiss franc. that the SNB has significantly increased the leeway to lower After the initial slump following the abandonment of the rates before hitting the economically effective lower bound on exchange rate floor against the euro in January 2015, the Swiss policy rates. franc has moved in a narrow range.

4 Other important sectors of the Swiss financial industry, such as pension funds and life insurers, are fully subject to negative interest rates. The impact of the negative interest rate policy on these sectors is relevant to the SNB if it affects the pursue of the objective of price stability and the respect of the mandate that the SNB “must gear its policy to the needs of the entire Swiss economy rather than the interests of individual regions or industries”.

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