Monetary policy report 2001


The inflation forecast published by the National Bank in December 2000 predicted that, at an unchanged interest rate of 3.5%, inflation would increase somewhat in the course of 2001 and slightly exceed 2% for a limited period of time. This forecast was based on a background of robust economic growth in 2000 and the massive rise in oil prices. At the same time, the National Bank noted that the gradual tightening of Switzerland’s monetary policy from autumn 1999 until summer 2000 and the anticipated economic slowdown in the US and Europe would help prevent an inflationary overheating of the Swiss economy. For 2001 and 2002, the National Bank projected real economic growth to slow to 2.2% and 1.6% respectively.

Subsiding inflationary pressures – lowering of the interest rate target range in March

In the course of the first quarter 2001, however, it became clear that price pressures were beginning to subside. This was due to the economic downturn in Switzerland and abroad as well as the faster-than-expected decline in oil prices. On 22 March, the National Bank reacted to this development by lowering the target range for the three-month Libor rate by 0.25 percentage points to 2.75%–3.75%. This was the first adjustment of the target range since mid-2000.

Interest rate target range left unchanged at the monetary policy assessment in June

Although the economy lost momentum in the subsequent months, the decline was moderate and the overall economic capacities remained extremely stretched. The National Bank assumed, as most observers did, that the US economy would recover slightly towards the end of the year. Inflation measured by the national consumer price index, which had dropped significantly in the first quarter due to special factors, rose again in the two following months and, at 1.5%, roughly equalled the average recorded in 2000. The new inflation forecast presented at the news conference on 14 June showed that the National Bank, assuming a short-term interest rate of 3.25%, expected inflation to stabilise at around 1.5% in 2003. At its monetary policy assessment in June, the National Bank therefore decided to leave the interest rate target range unchanged.

Interest rate cuts following the terrorist attacks in the US

In the second half of the year, it became increasingly clear that the US economy would not rebound as quickly as had first been anticipated. In addition, the economic downturn in Europe and, particularly, in Germany, roved to be more pronounced than expected. This also clouded growth prospects for Switzerland. At the same time, current inflation decreased. Therefore, even before the terrorist attacks of 11 September, the ground was prepared for a further reduction in money market rates. When the Federal Reserve and the European Central Bank (ECB) cut their interest rates by half a percentage point on 17 September, the National Bank moved forward its monetary policy assessment scheduled for 20 September and also lowered the target range by 0.5 percentage points to 2.25%–3.25%. Since the other central banks reduced their key interest rates by the same margin, the interest rate differential to other countries did not change. In the subsequent days, the Swiss franc came under strong upward pressure, especially against the euro. On 21 September, the National Bank indicated to the markets that it was extremely concerned about the development on the foreign exchange markets, and on 24 September, it reduced the interest rate target range by another 0.5 percentage points to 1.75%–2.75%. With this cut the National Bank acted in response to the appreciation of the Swiss franc, which threatened to aggravate the monetary conditions in a manner that was undesirable given the flagging economy.

Further reduction in the interest rate target range in December

At the monetary policy assessment in December, the National Bank decided to lower the target range for the three-month Libor rate by another 0.5 percentage points to 1.25%–2.25%. It acted in response to the further deterioration of the economic outlook and the associated decrease in inflationary pressure. The inflation forecast published at the news conference on 7 December is based on a three-month Libor of 1.75% and anticipates an average inflation rate of 0.9% for 2002, 1.3% for 2003 and 1.5% for 2004. At the same time, the National Bank based its forecast on an increase in real GDP of 1.5% in 2001 and around 1% in 2002.

Short-term increase of repo rates within the target range

With these four rate cuts, the National Bank reduced the target range for the three-month Libor rate by a total of 1.75 percentage points in 2001. Every time it lowered its interest rate – except on 24 September – the National Bank informed the markets that the three-month Libor rate would be kept in the middle of the target range for the time being. Since the markets had been anticipating a downtrend in interest rates since the beginning of the year, this meant that the National Bank had to let short-term repo rates climb temporarily. This was particularly the case in March, September and November, when there was the growing expectation that rates would be adjusted – possibly even ahead of schedule. In these cases, however, the National Bank was willing to make use of the flexibility offered by the target range and let the three-month Libor temporarily slip considerably below the middle of the applicable target range.

No signs of a long-term rise in prices

The substantial reduction in short-term interest rates effected during 2001 was facilitated in that the growth rates of the monetary aggregates did not signal a threat to long-term price stability. The money stock M3, which – overall – had grown only marginally from 1997 to mid-1999, increased steadily during 2001, but growth remained moderate. In the fourth quarter, M3 exceeded the previous year’s level by 4.8% on average.

Expansion of monetary base due to rising demand for banknotes

The seasonally-adjusted monetary base, which measures the liquidity supplied directly to the economy by the National Bank, registered a much stronger expansion. This increase is mainly attributable to the massive rise in banknote circulation, which was influenced by special factors such as the forthcoming introduction of euro banknotes and coins. The second component of the monetary base, the banks’ sight deposits at the National Bank, also rose while experiencing heavy fluctuations. These fluctuations were most likely triggered by the interaction between the markets’ interest rate expectations and the National Bank’s efforts to keep the three-month Libor rate near the middle of the interest rate target range.