Andréa M Maechler: Monetary policy in 2015 - a first assessment
Speech by Ms Andréa M Maechler, Member of the Governing Board of the Swiss National
Bank, at the Money Market Event, Geneva, 19 November 2015.
* * *
Accompanying slides can be found at the end of the speech and on the Swiss National Bank's website.
The speaker would like to thank Dirk Faltin, Marco Huwiler and Bettina Simioni for their valuable support in
preparing this speech. She is also grateful to Vincent Crettol and Peter Kuster for helpful comments and SNB
Language Services for their assistance.
Ladies and gentlemen
It is my great pleasure to welcome you tonight to our traditional Money Market Event. I feel
very honoured to be here in Geneva, the city of my birth, giving my first public speech for the
Swiss National Bank (SNB), having joined the Governing Board in July this year.
It has been a very eventful year for monetary policy in Switzerland. In January, the SNB took
two momentous decisions: It discontinued the minimum exchange rate against the euro, and
lowered the interest rate on sight deposits further into negative territory. Thus, the SNB's
monetary policy has changed significantly. Tonight, I shall provide a first assessment of this
new monetary policy environment.
My speech is divided into three parts. First, I shall discuss the SNB's monetary policy since
the discontinuation of the minimum exchange rate, and the impact on the Swiss franc
exchange rate. Second, I will assess how the negative interest rate as a policy instrument
has been transmitted to different segments of the financial markets. Finally, I shall discuss
the outlook for economic growth and inflation in Switzerland.
Following my speech, my colleague Dewet Moser will take a closer look at the many
operational aspects involved in the implementation of our monetary policy.
Monetary policy environment: breaking new ground
On 15 January, the SNB discontinued its minimum exchange rate of CHF 1.20 to the euro,
and announced a further cut in the interest rate on sight deposits to -0.75%. These decisions
were the response to international developments. Over the course of 2014, market
participants began to expect that the US central bank, the Federal Reserve would start
increasing its policy rates. Meanwhile, the ECB indicated that additional monetary stimulus
would be required in the euro area. As a result, the euro weakened substantially against the
US dollar.
The euro/Swiss franc minimum exchange rate came under intense pressure, and by
midJanuary 2015, it had become clear that it was no longer sustainable. Had the SNB not acted
as it did in discontinuing the minimum exchange rate against the euro, it would have been
forced to buy enormous amounts of foreign currency. The SNB's balance sheet would have
expanded rapidly, potentially to a size that would have severely impaired our ability to fulfil
our constitutional mandate in the long term.
Since the discontinuation of the minimum exchange rate, the SNB's monetary policy has
been based on two pillars, which are designed to mitigate upward pressure on the Swiss
franc and to ensure price stability over the medium term. The first pillar is the negative
interest rate on sight deposits at the SNB. The second pillar is our willingness to intervene on
the foreign exchange market as required. These two pillars are complementary and mutually
reinforcing policy instruments.
The negative interest rate
The negative interest rate applies to sight deposits above a certain threshold, held by banks
and other financial market participants at the SNB. This threshold was introduced to limit the
financial burden on banks. It was set at 20 times the minimum reserve requirements. By
linking the threshold to the statutory minimum reserve requirement, the SNB adopted a
measure that is both firmly anchored in law and for which clear rules exist. For depositors
that are not subject to minimum reserve requirements, a fixed exemption threshold of at least
CHF 10 million has been set.
The thresholds imply that banks which hold large sight deposits relative to their minimum
reserve requirements are affected most by the negative interest rate. Thus, like any other
monetary policy measure, the negative interest rate affects different market participants
differently. However, in the interests of the Swiss economy as a whole, it is important that the
negative interest rate be allowed to function as effectively as possible, by applying it broadly
and keeping exceptions to a minimum.
The aim of the negative interest rate is to reduce the relative attractiveness of Swiss franc
investments, and to counter upward pressure on the exchange rate. Hence, it is primarily
directed at the external contributions to monetary conditions in Switzerland. As such, the
negative interest rate is not an ordinary policy instrument. It is a consequence of the fragile
international environment and its exceptionally low interest rates. Historically, Swiss interest
rates have been lower than those of our main trading partners. This interest rate differential
is a reflection of our country's long-standing strengths, including political stability, sound
institutions, a resilient economy, and a first-class financial sector.
My first chart shows the interest rates of German and Swiss ten-year government bonds. The
orange area indicates the interest rate differential. As central banks around the world fought
to mitigate the worst effects of the global financial crisis, short-term interest rates in many
advanced economies fell towards zero. Importantly, foreign interest rates, including those in
Germany, have fallen more sharply than those in Switzerland. As a result, Switzerland's
interest rate differential had practically disappeared, making Swiss franc investments more
attractive than comparable investments in other currencies. By lowering the interest rate on
sight deposits into negative territory, the SNB restored the traditional interest rate differential
to more normal levels, as illustrated by the orange area in the chart.
The SNB's willingness to intervene in foreign exchange markets
A higher interest rate differential reduces the relative attractiveness of the Swiss franc.
However, financial markets may be exposed to a sudden increase in volatility, which could
lead to a sharp rise in the demand for Swiss francs. This is where our willingness to
intervene in the foreign exchange market plays a crucial role in stabilising the markets. For
example, this summer, when the Greek government announced a referendum on the
international bailout programme, we intervened in the forex market at a time of great market
volatility and global uncertainty. This willingness to intervene in the forex market as required
is a key pillar of our monetary policy.
The size of the SNB's balance sheet reflects our monetary policy measures. One
consequence of a larger balance sheet is larger fluctuations in the financial results. In the
first three quarters of this year, the SNB incurred a provisional loss of CHF 34 billion,
predominantly reflecting valuation effects following the discontinuation of the minimum
exchange rate. This is shown in chart 2. It is still too early to draw conclusions for the 2015
year-end result, particularly in the current volatile international environment.
Let me be clear, however: It is not the purpose of the SNB to generate and distribute profits.
Instead, the SNB's main concern is to conduct a monetary policy that serves the interests of
the country as a whole. Our monetary policy operations have a direct impact on the SNB's
balance sheet, meaning that substantial losses may occur in individual years. Significantly,
however, in the long term, our financial results should be positive, thanks to our monopoly on
creating banknotes and sight deposits, which ensures low funding costs.
The Swiss franc since the discontinuation of the minimum exchange rate
Our two-pronged monetary policy is proving effective in reducing the relative attractiveness
of the Swiss franc. After the sharp appreciation immediately following the discontinuation of
the minimum exchange rate, the franc has weakened steadily against the euro, despite
intermittent bouts of heightened financial market volatility during the summer. However, the
Swiss franc remains significantly overvalued. For example, the real effective exchange rate -
the Swiss franc's exchange rate against a basket of currencies of our main trading partners -
is still around 15% above its long-term average, compared to less than 10% at the end of
2014.
The situation on the foreign exchange market has not yet normalised. Chart 3 shows that
private capital outflows, which have traditionally balanced Switzerland's structural current
account surpluses, have turned into net inflows since the global financial crisis. Changing
investor preferences are behind this reversal of capital flows. While global economic
conditions have improved, substantial uncertainty remains, causing some investors to seek
the relative safety of the Swiss franc. This also applies to domestic investors, including large
institutional investors, which have partly repatriated their assets and investment returns. Until
investor preferences normalise, the franc is likely to remain under pressure. The second
quarter of 2015 suggests a return to net capital outflows - a development undoubtedly
supported by the negative interest rate. However, it is too early to say whether this is the
beginning of a new trend.
Transmission of the negative interest rate to financial markets
This brings me to the question of how the negative interest rate has been transmitted to the
different segments of the Swiss financial market.
With regard to money and capital markets, our experience so far shows that the negative
interest rate has worked remarkably well. The entire term structure of interest rates has
shifted downwards without generating market disruptions. This is illustrated in chart 4. After
an initial undershooting, the Swiss franc three-month Libor levelled off in the middle of the
SNB's target range of -1.25% to -0.25%. Other money market rates followed suit, leaving
spreads between the different money market rates more or less unchanged.
From the money market, the negative interest rate worked its way to the capital markets.
Government bond yields fell across the entire yield curve, with short-term yields dropping
more than yields of longer maturities. Yields on Swiss government bonds are currently
negative up to a maturity of 13 years. In the market for private sector bonds, interest rates fell
as well, but not by as much as government bond yields, reflecting the greater substitution
opportunities for corporate bond investors.
While the introduction of the negative interest rate caused interest rates on the money and
capital markets to decline, mortgage rates did not decrease to the same extent. Indeed, for
long-term mortgages, interest rates are slightly higher than they were at the beginning of the
year. This is because banks' refinancing costs have not fallen to the same extent as money
market interest rates. As a result, banks' interest margins have come under pressure.1 To
partially offset this effect, banks have raised their mortgage interest rates. As yet, therefore,
fears that the negative interest rate might contribute to stronger growth in mortgage lending
have proved unfounded.
The Swiss economy in a difficult environment
So far, I have spoken mainly about exchange rates and interest rates - that is, monetary
conditions in the Swiss economy. I would now like to turn to the real economy. Switzerland is
a relatively small open economy.2 In general, this means that international developments
matter a lot to Switzerland. However, during the global recession of 2009 and the sluggish
recovery that followed, the Swiss economy proved to be surprisingly resilient. The reasons
for this relatively strong performance are manifold: To start with, Switzerland did not suffer
from a housing market correction or over-indebtedness of the private sector. Moreover,
favourable labour market conditions and migration have remained a constant support to
private consumption.
Chart 5 shows the level of GDP for different countries, indexed to 100 at the respective
precrisis peak. Swiss GDP is now nearly 8% above its pre-crisis peak. As can be seen in the
chart, among large advanced economies this performance is matched only by the US.
Economic growth held up relatively well even in years when the economy faced a strong and
abrupt exchange rate appreciation. A major factor here is monetary policy: With its monetary
policy measures, the SNB was able to absorb some of the risks affecting the economy during
the various episodes of the financial crisis.
Another factor is the Swiss economy's high degree of competiveness. Chart 6 shows that
Switzerland topped the global competitiveness ranking once again in the World Economic
Forum's report for 2015-2016. Swiss companies' technological readiness, business
sophistication and flexibility are among the factors that make Switzerland one of the most
competitive countries in the world.
This is not to say that adjustment is painless. Far from it: Organisational changes are never
easy and cost-cutting is often painful - especially for employees. Moreover, the relative
resilience of real GDP growth is to some extent due to companies' willingness to accept
lower profit margins. Chart 7 shows real, i.e. inflation-adjusted, export volumes and nominal
export turnover. While nominal export turnover fell sharply, real export volumes held up much
better. Hence, when the strong appreciation of the Swiss franc raised prices for foreign
buyers of Swiss products, Swiss companies responded by cutting export prices, thereby
preventing a sharp fall in real export volumes. Further evidence for this 'margin compression'
comes from our own surveys, which SNB delegates for regional economic relations conduct
regularly among Swiss companies.
Global demand conditions have deteriorated somewhat in recent months. Emerging market
economies in particular - but also some commodity-producing countries - have seen
economic momentum fade. By contrast, major advanced economies continue to recover,
albeit at a modest pace. On balance, we expect the global economy to grow moderately in
the coming years. This should help to partially offset the drag from the overvalued Swiss
franc. Thus, following a contraction in the first quarter of 2015, economic activity in
Switzerland expanded again in the second quarter. In our estimation, GDP is likely to grow
by close to 1% this year.
Price stability is not in doubt
In the last part of my speech, I would like to present our inflation outlook. Last year, the
inflation rate - as measured by the consumer price index - averaged around zero. This year,
inflation has fallen well into negative territory. Two factors are behind this development: the
sharp appreciation of the Swiss franc following the discontinuation of the minimum exchange
rate and the pronounced fall in oil prices last year. These factors are transitory, and as such
do not pose a threat to price stability over time in Switzerland.
Exchange rate appreciation and the energy price decline are the results of international
spillovers that affect consumer prices primarily by lowering import price inflation.3 Chart 8
shows that most of the downward pressure on Swiss inflation is attributable to these
international spillovers. However, as can be seen in the chart, domestic price components
have shifted down as well. This harks back to the flexibility of Swiss companies, which I
referred to earlier. In particular, those Swiss companies that compete in markets for imported
goods have lowered their prices in order to maintain competitiveness in the wake of the
exchange rate appreciation. Such price cuts play an important role in restoring the Swiss
economy's price competitiveness over the medium term. They are thus part of the
adjustment process in response to the sudden exchange rate appreciation. That such a
process can be painful for some of the companies directly involved goes without saying.
For this year, we expect consumer price inflation to average about -1.2%. We think that the
inflation rate will reach its trough this quarter. For 2016, we expect average inflation of
-0.5%. As you can see from the chart, inflation will move back into positive territory in early
2017. These forecasts assume that the three-month Libor remains at -0.75% over the entire
forecast horizon, that the Brent crude oil price remains at USD 50 per barrel and that the
Swiss franc weakens.
Again, our forecasts show that the current period of negative inflation is temporary.
Nevertheless, even temporarily negative inflation rates are undesirable. Yet they cannot
always be avoided - especially during phases of strong exchange rate appreciation. What
matters is that inflation expectations remain firmly anchored and that monetary policy is able
to ensure medium-term price stability. Medium and long-term inflation expectations are still
positive. This can be seen in various surveys of inflation expectations, and is confirmed by
discussions between the SNB's delegates for regional economic relations and company
representatives from different sectors of the economy. Thus, we do not expect sustained
negative inflation, let alone a deflationary spiral.
Concluding remarks
This brings me to the end of my speech. Earlier this year, the SNB took some far-reaching
decisions: It discontinued the minimum exchange rate against the euro, and lowered the
negative interest rate on sight deposits significantly into negative territory. These measures
were necessary to promote adequate monetary conditions for the Swiss economy, and to
ensure the SNB's ability to provide medium-term price stability in the future.
Since mid-January this year, the SNB's monetary policy has been based on two
complementary pillars: The negative interest rate and our willingness to intervene on the
foreign exchange market as required. These instruments are proving effective at countering
excessive pressure on the exchange rate, thereby ensuring price stability in the medium
term. However, I would like to stress that, at current levels, the Swiss franc remains
significantly overvalued.
With an interest rate of -0.75% on sight deposits, we have gone far compared to most other
countries. We have observed that money and capital markets are functioning smoothly under
the negative interest rate. However, mortgage rates have not fallen to the same extent as
interest rates on money and capital markets. Hence, fears that the negative interest rate
could contribute to imbalances on the mortgage and real estate markets have so far proved
unfounded.
Finally, economic conditions remain challenging in Switzerland. The SNB monitors the
situation continuously, and our latest analysis and forecast will be published at the next
monetary policy assessment on 10 December. In general, we believe that the economy has
returned to a moderate path of recovery, although significant downside risks remain. These
originate, in particular, from the fragile international environment and exchange rate
developments. Currently, the inflation rate is too low, but the main factors pushing down
domestic inflation are of a transitory nature. Medium-term price stability is not in doubt.
Thank you very much for your attention.
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