Strong Frank: Is the Central Bank under pressure?

But this has changed now. Inflation has also fallen noticeably in the Eurozone; Inflation in November was only 2.4 percent, but the euro continued to fall. “The latest appreciation goes beyond the inflation gap,” says Elias Hafner, currency strategist at Zürcher Kantonalbank.

The speed of appreciation is also extraordinary. There were almost thirty days between 97 kuruş and 93 kuruş. According to Thomas Stucki, there is only one explanation for this: St. “Lower expectations for ECB interest rates,” said the head of investment at Kantonalbank of Wales.

Market participants have revised their expectations regarding the ECB’s interest rate path in recent weeks. At the end of November, markets had priced in four interest rate cuts for 2024, starting from mid-year. Meanwhile, five to six easing steps are expected, with the first likely as early as spring. The reason for the change in market expectations is the weak economic outlook and the rapid decline in inflation.

Interest rate cut expectations for Switzerland are less pronounced, because the base interest rate of 1.75 percent is less than half that in the eurozone and also because the economy there is more robust. The possibility of the euro’s interest rate advantage decreasing makes the franc more attractive to investors, thus gaining value in both nominal and real terms.

This is also illustrated by indices, also called real exchange rate indices. These are trade-weighted currency indices adjusted for inflation differences. The real effective franc index, calculated monthly by the SNB, has increased and reached its highest level since the franc shock in 2015. The main reason for this is the weakness of the dollar and Chinese yuan.

If you just use the euro as a reference, the real appreciation is slightly less pronounced and only really gained momentum in December, according to SNB data.

Real discretion hurts the industry

If the appreciation is greater than the relative change in prices, then this has real effects. Weekend shopping in Konstanz is now even more valuable, and holidays abroad are even cheaper. Imports are getting cheaper, but Swiss products are becoming more expensive abroad.

Therefore, the increase in value for the export-oriented industry occurred at a very unfavorable time. An icy wind has been blowing for months: Rising energy prices are driving up costs, demand from China and Germany is weak, order books are emptying; All these are symptoms of industrial stagnation. There have already been some layoffs due to poor order situation.

Again a little shorter work

In addition, the number of companies in the industrial sector is increasing and they are forced to implement short-time working practices. This is stated in press reports about companies and in applications submitted to employment offices in the canton. For example, the steel mill Gerlafingen SO, the Trumpf technology group for its plant in Grüsch GR and the mechanical engineering company Bystronic in Niederönz BE have introduced or announced short-time working. The increase can still be seen in the official figures of the State Secretariat. Not that a preliminary registration for short-time work compensation for Economic Affairs Seco until October (inclusive) does not constitute the use of the fund. However, an increase can be foreseen, but only a modest increase, according to Seco.

Moreover, at that time the euro was still at 0.98 francs. “Since then, the number of applications for short-time work has increased significantly again,” says Jean-Philippe Kohl, deputy director and head of economic policy at the Swissmem industry association, which supports its members in applications for short-time work, among other things.

Kohl believes this trend will continue. “It’s a poisonous mixture.” The pie is generally shrinking due to the global industry slowdown, but Swiss companies are having a particularly difficult time due to the strong currency.

Swissmem therefore expects the SNB to respond appropriately to the situation of Swiss industrial companies. “As long as price stability is not jeopardized, of course,” adds Kohl.

Foreign exchange purchases are controversial

The SNB has two tools for this: key interest rates or foreign exchange purchases. However, in the last evaluation, it was made clear that interest rate cuts were not a problem and that they were ready to intervene in the foreign exchange market, that is, to buy foreign currency. Because foreign exchange sales are no longer the focus.

Last year the SNB sold over 100 billion foreign currencies, thus deliberately supporting the Swiss Franc as it has a positive impact on inflation. It also managed to slightly reduce its huge foreign exchange investment portfolio, which caused a loss of $130 billion in 2022. Additionally, as the SNB announced this week, there will be a loss of $3 billion in 2023.

There has been speculation in the market as to whether the SNB has been activated for the past few days. A visible counter-movement begins when the price falls below 0.93. In addition, demand deposits held by banks at the SNB increased significantly for the first time in a long time in the week until January 5, reaching around 6 billion francs. This could be an indication of currency purchases. Because when the SNB buys foreign currency, it credits the Swiss franc balance to the banks.

“Actually, we are already expecting action from the SNB. The price increase last Thursday may be a result of this,” says Thomas Flury, foreign exchange expert at UBS.

But the SNB also has good reasons to wait before buying foreign currency, otherwise foreign exchange reserves and the central bank balance sheet will increase again. The fact that this could also lead to negative consequences was also revealed by the record devaluation loss in 2022 and the ongoing costs of paying interest on demand deposits. On the other hand, categorical rejection of intervention would mean an invitation to speculators.

The trend in the euro exchange rate is downwards

So is the franc steadily strengthening and will the euro soon cost just 80 centimeters? As long as inflation in this country is lower than in the euro area, the long-term trend will support the thesis. However, purchasing power parity models show that the euro-franc exchange rate has already fallen below fair value due to the inflation difference. ZKB estimates it at 96 centimeters. UBS sees the equilibrium rate at between 0.95 and 1.00 francs per euro. This explains why the majority of banking forecasts compiled by Bloomberg predict the euro-franc exchange rate to be close to parity in 2025. However, the predictions are for December.

More recent evaluations reveal a different picture: expert Stucki from SGKB expects a price of 92 to 93 centimeters for six to twelve months. Lower prices are also possible in moments of shock and escape to safe havens.

Technical counter moves are always possible. But in the long run, the franc will only weaken if the European economy makes a soft landing and Swiss inflation is above the euro zone. This is a very unlikely scenario. Therefore, the issue of intervention in the foreign exchange market will occupy the SNB for a long time.