Fading tailwinds
Just as in 2022, the Swiss franc is likely to record one of the best spot performances of any major currency in 2023. In our view, two key elements have been supporting the franc since last year. First, inflationary pressure has been much less acute in Switzerland than in its main trading partners. The resultant erosion in the nominal value of other currencies have put strong upward pressure on the franc. Second, the Swiss National Bank (SNB) has acted decisively to support the value of the franc through FX interventions as a way of curbing imported inflation.
However, the big drop in inflation in Europe and the US in recent months means the first factor has faded. And signs that domestic inflation is replacing imported inflation as the SNB’s main concern could mean the second factor supporting the franc also abates. In addition, the SNB is conscious that a strong franc could weigh on Swiss exporters, which would be especially unwelcome at a time when economic perspectives are already subdued. The SNB’s decision to keep the policy rateunchanged at its September meeting (when the franc was particularly strong) despite market expectation for a hike, reinforces this view.
In addition, we do not believe that the SNB will actively push for ‘normalisation’ ofits large balance sheet (equivalent to roughly 100% of Swiss GDP). In contrast to other major central banks that have moved toward reducing their balance sheets, the size of SNB’s balance sheet may continue to reflect interventions in the FX market to curb unwanted moves in the Swiss franc. At the same time, given that we think Swiss headline inflation is set to remain close to the central bank's 2% target and given its substantial holdings of foreign securities, it is difficult to see the franc declining significantly.
Inflation differentials vs. ratio of NEER and REER*
SNB’s FX interventions vs. Swiss imported inflation
Current account, portfolio inv. & foreign direct inv.
Swiss franc vs. 2-year interest rates differential
