The Swiss monetary watchdogs raised interest rates in their last two assessments; this Thursday they will announce another decision. What has happened so far with the return of nominal interest rates to positive territory and what does the expected further increase mean? Six questions and answers.
The currency watchdogs in Switzerland are pursuing one goal more credibly than elsewhere: price stability. But here too, inflation has overshot the target range. The next interest rate decision is now pending.
How has the return to positive interest rates been so far?
On September 22, the Swiss National Bank (SNB) announced that it would return to a positive interest rate. But for the interest rate decision to have an effect, monetary policy must also be implemented and short-term loans on the market must become more expensive accordingly. The indicator for this is the Saron, the interest rate at which banks in Switzerland borrow money overnight. The Saron rose from –0.2 to (initially only) 0.38 percent when the SNB key interest rate was increased to 0.5 percent on September 22. From the beginning of October it leveled off at around 0.45 percent.
The banks that maintain sight deposit accounts with the SNB receive interest on their deposits up to a limit at the base rate of 0.5 percent; everything above that remains without interest. This results in graduated interest on sight deposits. This gradation ensures that the banks trade part of their sight deposits with each other. The limit is calculated as a multiple (currently 28 times) of the minimum reserve requirement of a commercial bank, which is periodically recalculated by the SNB.
Interest rates on ten-year government bonds have risen even faster than short-term interest rates. Confederation bonds recently yielded a good one percent.
Since the first interest rate hike, the nominal interest rate differential against the euro has again increased significantly. German government bonds are currently yielding two percent. Against the background of the much higher inflation in Germany at the moment, the current real yield on German government bonds is still more negative than that on Swiss government bonds, as it has been for years.
What has the SNB done?
To ensure that interest rates actually rise and that the banks do not just park liquidity at the SNB, the SNB has siphoned off a great deal of liquidity since the interest rate decision in September. This can be seen in the current accounts, which have fallen by a full CHF 212.2 billion since September 16 (before the switch to positive key interest rates). This did not happen primarily by the SNB reselling foreign exchange, but largely by issuing interest-bearing SNB Bills and siphoning off liquidity via (reverse) repo transactions.
Unfortunately, the latest data on the SNB’s balance sheet items are not available until the end of October. In September and October, the SNB issued SNB Bills worth CHF 77 billion and carried out repo transactions for CHF 66 billion. From this it follows that she probably sold foreign currency for around 30 billion francs at the time.
How did the exchange rate develop?
On September 21, before the last interest rate hike, a euro cost 96 centimes. Now, before the next interest rate decision by the SNB, 99 centimes must be paid. A dollar, on the other hand, was available for 96 centimes, now it only costs 91 centimes. The franc has thus become nominally weaker against the euro and stronger against the dollar. However, the real value of the Swiss franc is more important for the export sector, for example. Due to the significantly lower inflation in Germany, this has decreased in trade-weighted terms both compared to the euro area and compared to the rest of the world. The exchange rate is not least influenced by the relative level of interest rates and defines the cost of imported goods. So a slowdown imports inflation.
Together with exchange rate changes, the exchange rate also determines the value of the SNB’s foreign currency investments. The stronger the Swiss franc, the less valuable the foreign currency investments are and the higher the loss that the SNB has to post. Billing is at the end of the year. At the end of the third quarter, the SNB posted a record loss of CHF 142.4 billion.
What does a further rise in interest rates mean for mortgage borrowers and tenants?
The interest rate on variable mortgages in Switzerland is now based on the Saron (and no longer on the Libor). The interest due is usually calculated retrospectively from the Saron interest rate. If the key interest rate rises and the central bank thus increases the Saron, the interest rates due on the variable mortgages will also rise with a delay. As a result, the government-defined reference interest rate will also be adjusted with even more delay. If this rises, this allows the landlords to increase current rents. On the other hand, longer-term expectations will determine the extent to which an increase in key interest rates will have a direct impact on the costs of new long-term fixed-rate mortgages. These have already increased.
What does this mean for interest on bank deposits?
Banks earn their income from fees for managing investments, but also from interest business and maturity transformation. They receive interest on liquidity held at the SNB and on loans granted, and in return pay interest on deposits made to them. Rate hikes should affect both the cost of borrowing and interest on bank deposits. However, since the financial institutions do not immediately receive higher interest rates on all of their loans, they are also reluctant to pay better interest on bank deposits. Admittedly, negative interest rates should now be a thing of the past. However, depending on the intensity of competition among banks, savings interest rates will only be adjusted with a time lag and are likely to remain lower than inflation for a while.
What to expect for a new rate hike now?
The SNB’s goal is price stability, defined as positive nominal inflation of less than 2 percent. The SNB’s interest rate decisions are based on its inflation forecast. In September, it forecast a gradual decline in inflation in 2023 from 3.4 percent in the first quarter to 1.7 percent in the fourth quarter due to base effects (energy is hardly ever becoming more expensive, supply chain problems are easing). However, she assumed that inflation would rise again from mid-2024 due to the second-round effects (higher costs being passed on to prices, higher wages). To prevent this, it should raise the key interest rate further.
The weakened value of the Swiss franc in real terms and the additional pressure from the higher administered prices for electricity and gas, among other things, as of January 2023 speak in favor of a further substantial interest rate hike. The slightly lower than forecast inflation in the fourth quarter and the generally expected economic slowdown offer some room for restraint. In the range from 25 to 75 basis points, an increase of 50 basis points to 1 percent therefore seems the most likely. As the SNB Observatory in its latest report, there is some choice. The SNB can also raise interest rates less and sell more foreign exchange to strengthen the franc and dampen imported inflation.