Swiss summertime blues

A weakening global economy and the appreciation of the Swiss franc are weighing on the outlook for Switzerland. In this Macro Flash Note, Senior Economist GianLuigi Mandruzzato looks at the fundamentals of the Swiss economy and the implications for monetary policy.

The latest data on the Swiss economy should be a cause for concern for policymakers. Although GDP grew on a quarterly basis in the first part of the year – preliminary Q2 GDP data will be released on 15 August – activity has lost momentum of late. According to Purchasing Managers’ Index (PMI) surveys, manufacturing remains in the doldrums, as it has been since Spring 2023, and the services sector has suddenly seen a decline in activity and new orders (see Chart 1).

Source: LSEG Data & Analytics and EFGAM calculations. Data as of 12 August 2024.

The loss of momentum in the Swiss economy is also evident in job market data. The seasonally adjusted unemployment rate rose to 2.5% in July, its highest level since late 2021, as job seekers rose by 23% from a year before while job vacancies fell by 26% over the same time span (see Chart 2). Not surprisingly, wage growth slowed to 0.6% year-on-year (YoY) at the start of 2024, according to Federal Statistical Office data.

Source: LSEG Data & Analytics and EFGAM calculations. Data as of 12 August 2024.

The uncertain outlook for the Swiss economy partly reflects tight monetary policy in the US and Europe and structural problems in China. In this context, the appreciation of the nominal effective exchange rate of the Swiss franc by around 5% since the end of May is another headwind to the outlook for the Swiss economy (see Chart 3), since a stronger franc will dampen activity in manufacturing and tourism. The adverse effect will likely peak in late 2024 and early 2025, in line with standard lags in the transmission of exchange rate shocks to the real economy.

Source: LSEG Data & Analytics and EFGAM calculations. Data as of 12 August 2024.

The only consolation for the Swiss private sector is that weakening economic growth makes it more likely that the Swiss National Bank (SNB) will further ease its monetary policy. This follows also from the faster-than-expected decline in inflation. In June and July, headline inflation stabilised at 1.3% YoY, below the SNB’s forecast of 1.5% YoY for the third quarter average. Thanks to the strength of the Swiss franc and a favourable base effect in energy and food prices, inflation is expected to decline further in coming months.

Over the past four quarters, inflation has been below the central bank’s forecasts in the first three months after their update was released at the end of monetary policy meetings (see Chart 4). This suggests that Swiss monetary policy was, and still is, tighter than the SNB anticipated and points to the need to cut interest rates further to reduce the risk of inflation hitting the lower end of the SNB’s 0-2% target range.

Source: LSEG Data & Analytics and EFGAM calculations. Q3 inflation shows July data. Data as of 12 August 2024.

A 25-basis point policy rate cut to 1.00% at the September meeting is very likely – markets are pricing it in with a probability above 90%. The latest developments in the Swiss economy suggest that rates could be cut to 0.75% in December or in early 2025, when inflation could fall below 1%. This would keep the real, inflation-adjusted, policy rate around 0%, in line with the SNB’s estimates of its neutral level.

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