Thomas Jordan: Comments on Swiss monetary policy
Speech by Mr Thomas Jordan, Chairman of the Governing Board of the Swiss National
Bank, at the 106th Ordinary General Meeting of Shareholders of the Swiss National Bank,
Berne, 25 April 2014.
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Mr President of the Bank Council
Dear Shareholders
Dear Guests
The Swiss National Bank (SNB) has a mandate to ensure price stability, while taking due
account of the development of the economy. The monetary policy decisions needed to fulfil
this mandate have a direct impact on the size and composition of our balance sheet. As a
result of the current size of our balance sheet and the nature of our investments, it can be
assumed that the annual results will continue to fluctuate significantly in the foreseeable
future.
Since summer 2007, the global economy has experienced a series of crises. At times, it was
on the brink of the abyss, and the threat to the Swiss economy was correspondingly great. In
order to fulfil our statutory mandate, we have been obliged to resort to unconventional
measures, rather than operating solely with the familiar monetary instruments. The most
exceptional measure was certainly the introduction and enforcement of the minimum
exchange rate against the euro. However, the creation of the stabilisation fund to take over
illiquid assets from UBS was also a special measure. In 2013, this episode was successfully
concluded. By contrast, the minimum exchange rate remains the SNB's key monetary policy
instrument. This remains true even though we have not had to enforce the minimum
exchange rate with foreign currency purchases since autumn 2012.
In my comments today I will explain the reasons why we are maintaining the minimum
exchange rate. I will begin with a brief look at global economic developments. Then I will
present our forecast for the global economy and the Swiss economy. Based on this, I will
follow with an examination of the outlook for price stability. As you know, in our view,
developments on the Swiss mortgage and real estate markets represent a risk for financial
stability. I will therefore use this opportunity to follow up with a brief presentation of our
considerations on this topic. I will round up my remarks with two examples which illustrate
the link between monetary policy decisions and our balance sheet.
Global economic developments in 2013
First, let me begin by reviewing the events of 2013. On the one hand, there was a certain
feeling of renewed confidence last year. This can be mainly attributed to the ebbing of the
European financial and debt crisis. The alleviation of the crisis is likely to have made a
significant contribution to Europe's emergence from recession. Meanwhile, economic growth
in the US firmed and the economy in Japan picked up perceptibly. On the other hand,
concerns about a number of emerging economies increased. One of the factors resulting in
more difficult financing conditions for emerging economies with structural problems was the
announcement by the US Federal Reserve that it intended to reduce its securities purchases.
Overall, growth in the global economy in 2013 was weak and uneven, and remained marked
by uncertainty. Will this situation change in the current year? Probably only to a limited
extent. According to our assessment, although the cycle has probably bottomed out, the
challenges remain formidable. I will now outline the international economic position in more
detail.
Global economic outlook for 2014
In 2014, growth in the global economy is likely to be stronger than in 2013. Nevertheless,
regional differences will remain substantial. While relatively robust growth can be expected in
the US, the signs are pointing to a modest and uneven recovery in the euro area. A slightly
stronger economic momentum than in 2013 can be expected in the major emerging
economies, but they will not attain former growth rates. We therefore anticipate that
expansion in the global economy will be no more than moderate. However, the recovery
remains subject to significant downside risks. This is still largely due to the European debt
crisis.
You may be wondering whether the debt crisis is not already over. The extreme risks have
indeed been eliminated. Reform programmes introduced in some euro area countries,
progress achieved in creating a banking union and measures taken by the European Central
Bank (ECB) have clearly brought about an alleviation of the crisis. But the crisis has not yet
been overcome - which is hardly surprising, since structural reforms are also required if this
is to be achieved.
It is important to acknowledge the efforts that have already been made in this respect in the
affected countries, and as an onlooker one should be cautious when making
recommendations. Yet there is broad consensus that additional structural reforms are
needed and should be implemented consistently. Such reforms should increase the growth
potential of the countries affected and allow them to significantly and sustainably reduce their
high level of unemployment and debt. Additional efforts are also required in the banking
sector. Consequently, the bank review to be carried out by the ECB is extremely important.
Only a healthy banking sector is capable of supplying the economy with sufficient credit.
However, risks also exist outside the euro area. The global recovery could be held back by
political tension in several regions as well as structural weakness in major emerging
economies.
A further source of potential turmoil is uncertainty about the future path of monetary policy in
the major currency areas. In particular, the divergence in the monetary policy direction could
increase. Overall, monetary policy in the advanced economies is likely to remain very
expansionary since production capacity is underutilised and inflation is low. But while in the
US the Federal Reserve is preparing the ground for a gradual normalisation of monetary
policy, the ECB is considering whether it should undertake further monetary policy easing. By
contrast, interest rate increases could become necessary again in a number of emerging
economies, to prevent further depreciation of their currencies and counter high inflation.
As you can see from this list of items, unfortunately the risks for economic growth have not
diminished. The European crisis may have become somewhat less virulent, but it has not
been overcome. Moreover, additional uncertainties have emerged and the Swiss franc is still
high. Overall, the environment remains extremely challenging for both the Swiss economy
and our monetary policy.
Outlook for Switzerland in 2014
I will now look at developments in Switzerland. In 2013, our economy did quite well, primarily
as a result of stable domestic demand. This year we are expecting the economy to maintain
a similar momentum, driven by domestic demand as well as, increasingly, by foreign
demand. Thus the global economy will supply positive growth impetus, which will assist
export industries, in particular. Accordingly, production capacity utilisation is expected to be
higher and companies should see further improvement in their financial situation. Given this
situation, investment looks set to regain momentum. During the months ahead,
unemployment is likely to decline slightly.
However, this essentially positive scenario is associated with external risks which I have
already outlined. Furthermore, the popular federal initiative approved in February to curb
immigration represents an additional element of uncertainty as far as the economy is
concerned. We do not know yet how the initiative will be implemented and what effect it will
have on our relationship to the EU. Consequently, the economic impact of the popular
decision cannot really be properly quantified at the moment, and this is why it has not been
included in our forecast. For 2014, we continue to expect economic growth of around 2%.
Inflation in Switzerland and the SNB's monetary policy
The greater economic momentum which we are forecasting will gradually lead to a better
utilisation of production capacity. The underutilisation which still prevails continues to restrain
consumer prices in Switzerland. Declining inflation abroad and the slightly stronger Swiss
franc are having a similar impact by dampening imported inflation. Thus the SNB's inflation
forecast shows that there is no risk of inflation in the foreseeable future. In 2014, inflation in
Switzerland is likely to amount to only 0%.
In addition, the international environment is still giving rise to high levels of uncertainty.
Consequently, the danger that the Swiss franc, as a safe haven, might suddenly be subject
to further upward pressure has not been averted. Short-term interest rates are practically
zero. For this reason, the minimum exchange rate is the right tool to avoid an undesirable
tightening of monetary conditions, since an appreciation of the Swiss franc would lead to a
further decline in import prices and a renewed threat of deflation. Given this situation, the
SNB is maintaining the minimum exchange rate of CHF 1.20 per euro. We remain ready to
enforce the minimum exchange rate, if necessary, by purchasing foreign currency in
unlimited quantities, and to take further measures as required. I would like to take this
opportunity of stressing, once again, that the minimum exchange rate does not represent a
peg to the euro. The Swiss franc is able to move freely above CHF 1.20 per euro. As I said, it
is high, and should weaken with time.
For many years, interest rates have been at a low level due to the overall economic situation.
However, the danger of a longer period of low interest rates is that imbalances can build up,
and we can indeed observe such a development in the Swiss mortgage and real estate
markets. Allow me therefore to give you our assessment of this situation.
Mortgage and real estate markets and countercyclical capital buffer
The Swiss residential mortgage and real estate markets have been growing strongly for
some time, giving rise to imbalances. Some time ago, these reached a level, in the view of
the SNB, that poses a risk to the stability of the banking system and hence the Swiss
economy.
Why does the SNB not simply increase interest rates in order to slow down the mortgage and
real estate markets? Although an increase in the interest rate would have a dampening
effect, it would, at the same time, intensify upward pressure on the Swiss franc and, given
the current situation, threaten price stability. Consequently, an interest rate increase is not an
option. Given this situation, in 2013, the SNB made a proposal to the Federal Council, after
consultation with the Swiss Financial Market Supervisory Authority (FINMA), that the
sectorial countercyclical capital buffer (CCB) be activated for the first time, at 1% of risk-
weighted mortgage loans financing residential property located in Switzerland. The Federal
Council acted on the proposal. Since last September, banks have therefore been required to
provide more capital backing for residential mortgage loans in Switzerland.
Certainly, momentum on the mortgage and real estate markets was dampened somewhat in
2013. However, the measures introduced by the beginning of 2013, such as the activation of
the CCB as well as those taken by the industry itself, were insufficient to prevent a further
build-up of imbalances. Therefore, the volume of mortgage lending was still rising at a
substantially stronger pace than national income. As a result, in Switzerland as a whole, debt
was increasing significantly faster than people's capacity to offset this debt with income. This
development is particularly critical because the correlation between mortgages and national
income is very high, both in historical terms and compared with other countries. In addition,
in an environment of persistently low interest rates, coupled with banks' undiminished
appetite for risk, the danger remained considerable that imbalances would build up further
unless additional countermeasures were taken.
In January 2014, therefore, acting on a proposal by the SNB, the Federal Council increased
the CCB from 1% to 2% of risk-weighted positions financing residential property in
Switzerland. The deadline for compliance is 30 June 2014. As part of its proposal, the SNB
drew attention not only to the cyclical risks but also, once again, to the high risks in mortgage
lending, especially in the area of affordability.
Some three months have passed since the CCB was increased. Based on the data currently
available for the first quarter of 2014, the all-clear still cannot be given, in our view. In the first
quarter of 2014, momentum in real estate prices was similar to that in the previous year and
therefore has not further diminished. However, for an idea of the overall picture we are still
lacking important data. A definitive assessment of the latest developments would therefore
be premature.
So we will continue to monitor developments on the mortgage and real estate markets
closely. Any decisions on further measures must be made in the light of these observations.
The SNB therefore regularly examines, first, whether the CCB needs to be adjusted.
Depending on how the situation develops, this might need to be an upward or a downward
adjustment. Second, the authorities are working on the specification of measures that would
target risks in the area of affordability.
Monetary policy and the SNB balance sheet: Flexibility as the key factor
In the case of the CCB, the SNB plays an important role because it can make proposals for
its activation, alteration or deactivation. However, this instrument does not have any impact
on our balance sheet. By contrast, our monetary policy decisions as well as other measures
aimed at stabilising the financial system are reflected in the composition and size of the
balance sheet. Accordingly, it is of key importance for the effectiveness of our measures in
the fields of monetary policy and financial stability that we have the option of making flexible
use of our balance sheet. There are therefore no statutory limitations with respect to the size
or composition of our balance sheet.
This flexibility played a major role in ensuring that we remained capable of acting during the
crisis, even in very difficult conditions. It enabled us to fulfil our mandate of ensuring price
stability and also of making a contribution to financial stability as part of this mandate.
Let me give you two examples of the way in which we make flexible use of our balance
sheet. For topical reasons, I would like to start by talking about the creation of the
stabilisation fund. The stabilisation fund, as we called it, was an undertaking which
commenced in 2008 and was successfully concluded last year.
What was involved? You will recall that in October 2008 a Swiss big bank, UBS, was in
substantial difficulties. Financial stability was threatened and intervention by the authorities
was absolutely necessary. Consequently, the Federal Council, the Swiss Federal Banking
Commission (predecessor of FINMA) and the SNB decided on measures to stabilise UBS
and thereby strengthen the Swiss financial system. The core element in the package of
measures was the stabilisation fund, which took over illiquid assets from UBS totalling almost
USD 40 billion. The SNB funded 90% by granting the stabilisation fund an interest-bearing
loan. For its part, UBS provided the stabilisation fund with equity corresponding to 10% of the
transferred assets.1 Moreover, to strengthen UBS's equity, the Swiss Confederation
subscribed to mandatory convertible notes in the amount of CHF 6 billion.2
By April 2009, the illiquid assets had been transferred to the stabilisation fund from UBS.
Subsequently, the portfolio was managed and reduced. The main goal was complete
repayment of the loan to the SNB. Sales as well as principal repayments and interest
payments did indeed result in a gradual repayment of the SNB loan. By mid-August 2013,
the loan had been fully repaid. Finally, in November, UBS purchased the stabilisation fund by
reimbursing the SNB its contractual share in the fund equity. At this point, the stabilisation
fund assets were entirely liquid.
The conclusion of this transaction was a major and exceptional achievement. To strengthen
the financial system, the SNB had stated, in autumn 2008, that it was prepared to finance the
takeover of assets up to a value of USD 60 billion by the stabilisation fund. For the success
of this undertaking it was important that we could handle our balance sheet flexibly. This
package of measures enabled both investors and savers to regain confidence in UBS.
The second example I would like to mention here is the introduction of the minimum
exchange rate in September 2011. This rate was introduced to correct a massive
overvaluation of the Swiss franc arising from adverse developments on the foreign exchange
market, and thereby avert the threat of a deflationary trend. I have explained to you why this
instrument is still needed and is being enforced by us without any restriction. A measure like
the minimum exchange rate can only succeed if the central bank is totally credible, in other
words, if people believe it will actually defend the rate, if need be. Words can certainly
achieve a great deal in the financial markets. But this only holds true if they are followed up
with deeds when necessary. In the case of the minimum exchange rate, the deeds in
question are unlimited foreign currency market interventions. In 2012, we were required to
enforce the minimum exchange rate with extensive foreign currency purchases, and our
balance sheet total increased significantly. If there were statutory restrictions on our balance
sheet we would be unable to introduce and enforce a measure of this kind. The financial
markets would call into question both our resolve and our ability to see the measure through.
Concluding remarks
Ladies and gentlemen, I come to my concluding remarks. Even seven years after the onset
of the financial crisis, the environment remains very challenging for our economy and for
Swiss monetary policy. With interest rates close to zero and a high Swiss franc, the minimum
exchange rate is still the key monetary policy instrument for the SNB.
Our monetary policy decisions have caused the SNB balance sheet to increase considerably.
Due to the size of the balance sheet and the uncertainty on the capital markets, annual
results are expected to be volatile in the foreseeable future. That is why we cannot provide
you with any forecasts of the SNB's future annual results.
We are certainly very aware that the lack of a dividend is painful for many shareholders.
However, as you know, the SNB is obliged by constitution and statute to act in accordance
with the interests of the country as a whole. Its primary goal is to ensure price stability, while
taking due account of the development of the economy. The SNB is required to gear its
monetary policy to this goal alone, and not to making profits. I would therefore like to thank
you, our shareholders, also on behalf of my colleagues, Jean-Pierre Danthine and Fritz
Zurbrügg, for your loyal support of and understanding for the activities of the SNB. The
Governing Board thanks the SNB staff for their untiring service to our institution. Thank you
all for your attention.