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Contrary to expectations, Swiss inflation data for January came in notably weak this morning, confirming our view that the SNB will now effectively loosen monetary policy, primarily through the exchange rate before it cuts the policy rate by 25bps to 1.5% on March 21st.
Despite upside pressures emanating from VAT increases at the start of the year, the headline rate of inflation fell from 1.7% to 1.3% YoY, against consensus looking for an unchanged reading. Similarly, the core measure also fell from 1.5% to 1.2% YoY, despite consensus looking for a slight increase to 1.6%. This now leaves inflation on track to undershoot the SNB’s conditional Q1 forecast of 1.8% by some margin, despite the prior round of prints having fractionally beaten the Bank’s 1.6% forecast for 2023 Q4. Perhaps more significantly, it also calls into question projections for later this year too. The SNB had predicted that headline inflation would rise back to 2% in Q2 and Q3, the top of the Bank’s tolerance band, a key factor influencing some sell-side desks to maintain calls for a hold in rates at March’s meeting.
With this now looking doubtful, it adds further weight to our view that deflation risks should prompt a rate cut when the Bank meets next month.
More timely measures of inflation suggest price pressures in the Swiss economy are even weaker than the annual measures suggest. Headline inflation increased just 0.2% MoM and is now tracking at -0.09% on a three-month annualised basis. Both core inflation measures also fell into outright deflation, a concerning outcome especially given the upwards impact of VAT increases. The benchmark measure of core inflation, which removes seasonal produce, energy and fuels, fell from 0.17% to -0.29% MoM, leaving the three-month annualised rate at -0.5%, while stripping out administered prices as well, i.e. electricity prices, the core rate fell further from 0.19% to -0.42% MoM, resulting in the three-month annualised rate to fall from 0.19% to -0.91%.
Once again, most of the disinflation pressure on headline inflation stemmed from imports, which fell further from -0.69% to -1.35% MoM. This contributed -0.22pp to the headline measure of inflation. While many will point towards the abolition of import duties to explain the significant drag, we note that imports have been providing a deflationary drag for three months now and likely motivated the SNB to drop its CHF appreciation bias at its December meeting.
With external inflation and growth conditions remaining weak, we expect the import channel to continue providing a deflationary impulse, unless this is counteracted by a weaker franc.
The only notable comfort for the SNB in today’s inflation release was the fact that private services inflation remained somewhat stable at 0.266% MoM, leaving the three-month annualised rate just shy of 3%. However, we think this likely reflects the increase in taxes at the start of the year as opposed to strong underlying price pressures, with VAT increasing 0.4pp to 8.1% and the accommodation rate rising 0.1pp to 3.8%. As a result, we expect domestic inflation to fall back from its current rate of 0.65% MoM towards its six-month average of 0.14% in the coming months, further fuelling disinflation in the annual rates of headline and core inflation.
All told, today’s data confirms our view that inflation pressures in the Swiss economy are extremely weak and will almost undoubtedly lead the annual measures of inflation to undershoot the SNB’s forecasts come March.
This in isolation should motivate the SNB to cut rates next month. However, the SNB won’t only be factoring in domestic conditions, but also the development of the eurozone economy. Here, we think the macro backdrop is also deteriorating with the eurozone economy effectively in recession by our measures. This should begin to take its toll on the pace of core inflation, which we expect to cool further in February following a transitory uptick in January due to seasonal factors. As a result, we expect the ECB to cut twice in Q2, and will have lowered the deposit rate by 50bps to 3.5% by the time the SNB meets on June 20th. The risk this poses towards a stronger franc, through both the haven and rates channels, adds further credence to our view that the SNB will be the first G10 central bank to cut next month as it effectively aims to mitigate future appreciation in the Swiss franc.
Ahead of its March decision, however, we expect the SNB to fine-tune its monetary stance through the exchange rate, effectively intervening to weaken the franc, likely when EURCHF drops sustainably below 0.945 by our estimates.
The central bank’s tolerance threshold could soon rise to 0.95 should data released in the next fortnight allude to even weaker external inflation pressures. Given the reaction in FX markets to today’s data, we don’t expect the SNB to immediately begin intervening as EURCHF now finds itself trading close to half a percent higher at 0.947. While the response in spot and short-term interest rate markets has been significant this morning, with the odds of a March cut rising from 0.4% to 0.66%, the reaction in the options space hasn’t been as significant, with front-end vol continuing to trade close to the bottom of its range since December.
In our view, given the ongoing shift in the SNB’s policy stance and the usual teething problems this causes in markets due to the opaque nature of the central bank’s FX interventions, we think this presents a good opportunity to own vol in the cross over the near-term.
Drawing battle lines: the SNB’s intervention tolerance could increase from 0.945 to 0.95 in the event of weak eurozone data
In response to today’s data, we are revising up our forecasts for EURCHF.
We now see the cross trading at 0.955 at month-end, before rising up to 0.98 over the upcoming three months. This effectively brings forward our six month-view, reflecting the faster-than-anticipated pace of disinflation. In addition to this, we now see the cross returning to parity at the end of 2024, an outcome we previously saw as unlikely this year.
We now expect earlier CHF depreciation as the SNB looks to guard against deflationary pressures
*Previous forecasts are in parentheses
Authors:
Simon Harvey, Head of FX Analysis
María Marcos, FX Market Analyst