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A new premise for SNB monetary policy?

KOF Forecast Conference, Zurich, 01.10.2015

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After the Swiss National Bank (SNB) decided, in January this year, to discontinue the minimum exchange rate, the Swiss franc appreciated sharply. Moreover, the negative interest rate on sight deposits at the SNB has meant that interest rates in the money and capital markets have fallen further, partly into negative territory. By contrast, mortgage rates have actually increased slightly. At first glance, therefore, it appears that the parameters for the Swiss economy and monetary policy have changed fundamentally.

Many companies and industries are, undeniably, suffering under the strength of the Swiss franc. The currency's appreciation since 2007 even makes the appreciation shocks of earlier decades pale in comparison. However, a strong Swiss franc does not in itself fundamentally change the parameters for Switzerland. Moreover, for exporters, economic developments abroad are even more crucial than the exchange rate. The SNB expects the moderate pace of global economic growth to continue, supported by expansionary monetary policy and lower commodity prices. This should help mitigate the negative effects of the strong Swiss franc on the Swiss economy.

As a result of the SNB's negative interest rate, many money and capital market interest rates have undergone a 'change of parameter' sign - but only in terms of their mathematical sign. The negative interest rate has made a return to more normal conditions possible; the traditional interest rate differential vis-à-vis foreign countries has been re-established, having all but disappeared as central banks in most advanced economies cut their reference rates to virtually zero. The differential makes the Swiss franc less attractive to investors. Thus, together with the SNB's willingness to intervene as required in the foreign exchange market, the negative interest rate supports a further weakening of the franc. In this way, current monetary policy takes account of the challenging situation facing the Swiss economy.

Despite a slight rise in mortgage rates, the negative interest rate is not a tool with which to combat imbalances on the Swiss mortgage and real estate markets. On the contrary. The current low interest rate environment could actually increase the risks to financial stability even further. First, the very low rates could prompt investors to invest more in real estate, thereby driving up prices, especially in the residential investment property segment. A second risk arises when banks grant more long-term loans as a cushion against falling margins. However, this increases the maturity mismatch and thus the interest rate risk in banks' balance sheets. Third, in an environment of low interest rates, non-bank providers could increase competition on the mortgage market. This, in turn, would weigh on margins, profits, and ultimately the banks' capital.