The Swiss Economy in 2017: The SNB Is Battling a Structurally Strong Swiss Franc

Two years after the abolition of the EUR/CHF exchange rate floor and the introduction of negative interest rates, the Swiss National Bank (SNB) is expected to change direction in 2017, albeit less radically. According to Credit Suisse economists, the SNB may tolerate a stronger Swiss franc next year and intervene less actively in the foreign exchange market. More and more export industries have regained their competitiveness and the domestic economy is growing robustly, although with below average momentum. In addition, an in-depth analysis in Monitor Switzerland shows that the Swiss franc will remain a strong currency in the long term, as it mirrors the success of highly productive export industries. By contrast, the SNB is likely to retain its policy of negative interest rates until the end of 2017, at least. According to Credit Suisse's forecasts, the Swiss economy as a whole will grow by 1.5 percent in 2017.

Credit Suisse economists take the view that the export sector has largely turned the corner. 'Although there are certainly sectors where export volumes are continuing to shrink, and headcounts are still falling in most sectors, the number of these is gradually decreasing,' says Oliver Adler, Head of Economic Research at Credit Suisse. In addition, the differences between sectors are already significantly smaller than they were while the earlier franc appreciations were being 'digested,' and much smaller than during the 2008/09 financial crisis. 'This suggests that more and more sectors are regaining their competitiveness,' Oliver Adler continues. However, taking the example of the mechanical engineering sector, Monitor Switzerland demonstrates the tribulations of an export sector that is particularly sensitive to fluctuations in exchange rates. Thus, since 2010, revenue growth in Swiss francs in this sector has been lagging behind that of its German counterpart by almost 40 percent.

Lower Immigration Is Reducing Growth in Consumer Spending

Thanks to the recovery of the export sector, it has become unlikely that domestic demand will collapse. Accordingly, Credit Suisse economists expect the domestic economy to be a pillar of Swiss economic growth in 2017 too. But once again there will be only limited domestic growth impetus. Three factors make an acceleration in private consumption unlikely: First, the immigration-led rise in demand is expected to be around one-fifth lower than in the previous year, as immigration will probably continue to slow. Second, the period of increasing purchasing power thanks to falling inflation is over - restrained pay increases once again contrast with a slightly rising price level. And third, consumer sentiment will probably remain depressed owing to ongoing uncertainty in the labor market.

State Holds Back despite Interest Rate Advantage

According to Credit Suisse economists, it is unlikely that the state as a driver of demand will step into the breach and help revitalize the domestic economy. Lower or even negative refinancing costs would favor this; these yield annual savings of over CHF 200 million for the federal government, and they have reduced the cantons' interest costs by around CHF 1.6 billion. But instead of accumulating debt and earning from it, the federal government in particular has held back on issuance. 'This is understandable because additional expenditure is not automatically available for supporting sustainable growth,' says Oliver Adler. Fiscal stimuli are not good at mitigating margin declines in the export sector.

Low Interest Environment Spurs Real Estate Investment

By contrast, construction investment is expected to accelerate. The decisive factor here is residential construction, which continues to enjoy a tailwind from the very low interest rate environment (key point: severe shortage of investment opportunities). However, the supply of apartments is growing faster than demand and therefore vacancies are likely to increase further. 'Almost two years after negative interest rates were introduced, it can be concluded that they probably stimulated the real estate market too much,' says Oliver Adler. If the low or negative interest rate environment persists, the problems in financing retirement provision will worsen. Still, the most obvious risk of negative interest rates, i.e. that investors turn their bank deposits into cash, has not yet materialized.

SNB: Interest Rates Unchanged, but Less Intervention in 2017

Owing to the side effects of negative interest rates, Credit Suisse economists do not expect the SNB to lower rates further in 2017. An interest rate increase is not on the cards either, for the moment. However, Credit Suisse economists predict that the SNB will intervene less actively in the foreign exchange market during 2017 and could tolerate a stronger Swiss franc. Nevertheless, the SNB is unlikely to cease its foreign currency purchasing explicitly and abruptly and it will probably react to sharp appreciations with increased interventions on the foreign exchange markets in the future too. According to Credit Suisse forecasts, the Swiss franc will continue to be overvalued against the euro.

Switzerland Showing Symptoms of the 'Dutch Disease'

'The appreciation of the Swiss franc is also the result of higher profits from foreign trade,' says Maxime Botteron, the author of an analysis on the balance of payments on current account in Monitor Switzerland. For example, despite the strength of the Swiss franc, Switzerland realizes a surplus from international trade and cross-border investment income of around CHF 65 billion per year, or 10 percent of gross domestic product (GDP). This large surplus can mainly be attributed to a few highly productive sectors, namely pharmaceuticals, the watch industry, commodity trading (transit trade), and financial services. As a result, Switzerland is showing clear symptoms of the 'Dutch Disease,' in other words a strong currency driven by an export boom in a few sectors. The finding that the surplus sectors are fundamentally strong is underscored by the fact that the franc appreciation has so far had little influence on those sectors' exports. The strength of the Swiss franc is thus the flipside of the fundamental strength of certain export sectors. As long as these remain successful, the Swiss franc will also tend to be structurally strong. Credit Suisse economists believe that any move to actively weaken the surplus sectors or introduce special taxation of their surplus would be counterproductive. Politicians have hardly any means to prevent the strength of the Swiss franc. Monetary policy should limit itself to reducing temporary overvaluations.

Further Content from the Current Edition of Monitor Switzerland

Predatory Pricing in the Hotel Market

In the past five years, the number of overnight stays in the hotel markets in Basel, Geneva, and Zurich has been increasing, in some cases sharply. In view of the marked increase in supply, competition is soon expected to intensify in these cities too.

Fear of President Trump

The latest political changes in the US and Europe have aroused fears among Swiss industrial companies of greater protectionism, as a survey among the participants in the PMI panel of procure.ch, the Association for Procurement and Supply Management, shows.

The publication Monitor Switzerland is published quarterly and is available online in German, French, Italian, and English at: www.credit-suisse.com/research (Swiss Economy).The next issue will be published on March 15, 2017.