Moderate Swiss franc depreciation is on the cards

While rising geopolitical tensions in Ukraine have offered some temporary support to the Swiss franc, the franc has generally performed poorly since the European Central Bank (ECB) adopted a more hawkish tone at its Governing Council meeting on 3 February. While the franc’s underperformance against the euro (moving roughly from CHF1.04 to CHF1.06 in two days) has been most visible, the Japanese yen and the Swedish krona, which both have dovish central banks, have lost ground to the euro as well. This suggests the franc is likely to continue to be penalised by a central bank that is in no rush to normalise its monetary policy. This is because domestic inflationary pressure is consistent with the Swiss National Bank’s mandate (a rise in consumer prices of less than 2% per annum) but also because an unsupportive interest rate differential should help curb the franc’s strength.

Before its recent weakness, the franc had been relatively strong for several months, helped by the fact that inflation pressure in Switzerland has been lower than among its main trading partners. The relative stability of the real effective exchange rate has reduced the SNB’s concerns about the franc's nominal strength, as SNB president Thomas Jordan explained in a recent TV interview. Jordan highlighted that higher inflation outside Switzerland could lead the franc to appreciate in nominal terms but stay unchanged in real terms, meaning the nominal rise does not have a negative impact on the economy. This explains the lack of SNB intervention in the FX market. Indeed, using sight deposits as a proxy, the SNB does not seem to have intervened in recent months to curb franc appreciation.

Overall, although inflation differentials will likely continue to support the franc (in nominal terms), our view id that the SNB will prefer to allow other major central banks to normalise their monetary policies first. Looking expensive relative to rate differentials and notwithstanding short-term volatility linked to geopolitical tensions, the franc could therefore depreciate over the course of the year (although moderately because of supportive capital flows).

Our projections for the EUR/CHF rate are CHF1.05 on a three-month horizon, CHF1.06 on a six-month horizon and CHF1.08 on a 12-month horizon.