SNB to be forced to cut interest rates again - Capital Economics
Nordic & Swiss Economics

SNB to be forced to cut interest rates again

Nordic & Swiss Chart Book
Written by Andrew Kenningham

The decision by the SNB to scrap its currency ceiling five years ago coincided with it slashing interest rates to a record low to reduce the attractiveness of holding Swiss francs. Alas, this ‘deterrence effect’ is not what it used to be: whereas the gap between Swiss and euro-zone interest rates widened to 55bps in January 2015, it has narrowed to just 25bp following the ECB’s slow-motion easing cycle. (See Chart 1.) What’s more, if our view that the ECB will be forced to loosen policy again proves accurate, the gap will narrow even further later this year. This will surely push the franc higher against the euro. The SNB has relied on FX interventions to counter bouts of upward pressure on the franc since 2015, but we think it is only a matter of time before it acts to re-widen the interest rate differential. Accordingly, we forecast a rate cut, to -1.00%, albeit not until the second half of this year.

  • The decision by the SNB to scrap its currency ceiling five years ago coincided with it slashing interest rates to a record low to reduce the attractiveness of holding Swiss francs. Alas, this ‘deterrence effect’ is not what it used to be: whereas the gap between Swiss and euro-zone interest rates widened to 55bps in January 2015, it has narrowed to just 25bp following the ECB’s slow-motion easing cycle. (See Chart 1.) What’s more, if our view that the ECB will be forced to loosen policy again proves accurate, the gap will narrow even further later this year. This will surely push the franc higher against the euro. The SNB has relied on FX interventions to counter bouts of upward pressure on the franc since 2015, but we think it is only a matter of time before it acts to re-widen the interest rate differential. Accordingly, we forecast a rate cut, to -1.00%, albeit not until the second half of this year.
  • The Swiss economy grew for the third quarter in a row in Q3 but is not firing on all cylinders. CPI inflation crept back above zero in December but remains perilously weak.
  • The Swedish economy appears to have ended 2019 on the back foot. While the Riksbank raised the repo rate back to zero in December, we forecast that it will reverse course before long.
  • Economic growth in Norway has lost a bit of momentum but is likely to gather pace again if oil prices increase as we expect. We think the balance of risks is skewed towards tighter rather than looser policy.
  • The Danish economy has shifted down a gear over the past six months. Meanwhile, the Nationalbank intervened in the FX market to strengthen the krone for the third month in a row in December.
  • Similar to Denmark, activity in Finland’s economy appears to have moderated at the end of 2019. Amid continued signs of weakness in the labour market, GDP growth is likely to remain sluggish this year.
  • The sharp downturn in the tourism sector is continuing to take a toll on the Icelandic economy. The sharp drop in inflation to a 19-month low in December may yet tilt the balance towards further rate cuts.

Chart 1: Interest Rates (%)

Sources: Refinitiv, Capital Economics


Switzerland

  • The Swiss economy is stuck in a low gear. Admittedly, GDP rose by a robust-looking 0.4% q/q in Q3 (2). However, this was skewed by a weather-related surge in energy exports, as well as continued expansion in the pharmaceutical sector. Growth in the rest of the economy was closer to zero.
  • Looking ahead, the KOF Economic Barometer suggests that annual GDP growth will stay below 1% y/y until at least mid-year (3), which is consistent with sluggish gains on a quarterly basis. And while December’s increase in the manufacturing PMI suggests that conditions in industry have stopped getting worse (4), weakness in neighbouring Germany suggests that any recovery will be slow.
  • Headline inflation rose back above zero in December (5) but, at just 0.2%, remained extremely weak. The SNB appears to have intervened in the FX market in early January to resist upward pressure on the franc (6) and the Bank will remain poised to resist further spikes in the currency. If our forecast for the ECB to loosen policy this year proves accurate, we think that the SNB would more likely than not cut its policy rate to -1.00%, probably in H2 (7).

Chart 2: GDP Growth

Chart 3: KOF Economic Barometer & GDP

Chart 4: Manufacturing PMI & Industrial Production

Chart 5: Headline CPI & PMI Input Prices

Chart 6: Swiss Francs per Euro & SNB Interventions

Chart 7: Swiss Policy Rate (%)

Sources: Refinitiv, Capital Economics


Sweden

  • The Swedish economy is in a weak patch. The PMIs remained below 50 in December and are consistent with the economy having contracted in Q4 (8). Admittedly, the series (9) understated growth in Q3 and, although volatile, private sector production data paint a rosier picture. However, the broad-based weakness in surveys suggests that the economy is struggling to build momentum.
  • The outlook for domestic demand is overshadowed by a deterioration in the labour market (10) and the downward trend in consumer confidence suggests that household spending growth is likely to stay subdued in the near term. Meanwhile, the continued declines in new housing starts point to further annual falls in new dwellings investment (11).
  • CPIF inflation was unchanged at 1.7% in December and given that resource utilisation is falling, we expect price pressures to remain below target over the coming years (12). All told, while the Riksbank raised its repo rate back to zero in December, as was widely expected, we are comfortable with our non-consensus view that it will loosen policy again and have pencilled in a cut back to -0.25% in H2 (13).

Chart 8: PMIs and GDP Growth

Chart 9: Private Sector Prod. & GDP (% q/q)

Chart 10: Unemployment Rate & PMI

Chart 11: New Housing Starts &
Dwellings Investment (% y/y)

Chart 12: Core Inflation & Resource Utilisation

Chart 13: Repo Rate (%)

Sources: Refinitiv, Bloomberg, Capital Economics


Norway

  • While the Norwegian economy remains a bright spot, it lost a bit of steam in late-2019. Monthly mainland GDP data for November suggest that the economy grew by about 0.3% q/q in Q4, down from 0.7% in Q3 (14). Meanwhile, the forward-looking component of the Norges Bank’s Regional Network Survey is also consistent with a slowdown in annual GDP growth to about 2% in mid-2020 (15).
  • The economy was always likely to slow a bit as previous falls in the price of oil fed through, and manufacturing output growth has already started to moderate (16). However, with oil prices set to rise this year we expect activity to regain momentum before long. Tight conditions in the labour market are likely to continue to support wage growth (17) and hence household spending.
  • The Norges Bank’s preferred measure of inflation (CPI-ATE) fell to a 14-month low of 1.8% in November (18), but we expect it to recover and to remain just above the Bank’s 2.0% target over the coming years. Our base case is that the Bank will leave its key policy rate on hold at 1.50% into 2022. But if anything, we think that it is more likely to hike than to cut next (19) and we are bullish on prospects for the NOK.

Chart 14: Mainland GDP Growth

Chart 15: Mainland GDP & Firms’ Output Expectations

Chart 16: Manufacturing Output & Oil Prices (% y/y)

Chart 17: Labour Costs & Wage Expectations (% y/y)

Chart 18: Headline and Core Inflation (%)

Chart 19: Policy Rate Changes Vs. Oil Prices

Sources: Refinitiv, Statistics Norway, Norges Bank, Capital Economics


Denmark

  • The Danish economy has shifted down a gear over the past six months. While the national accounts data are volatile, GDP growth slowed from 1.0% q/q in Q2 to 0.4% in Q3 and surveys suggest that activity has remained soft (20). Conditions in the industrial sector in particular appear to have weakened, in line with the plunge in the manufacturing PMI (21).
  • Looking ahead, while firms’ hiring intentions suggest that employment growth will remain solid in early-2020 (22), earnings growth appears to have peaked and consumer confidence is consistent with just subdued growth in household spending over the coming quarters (23). Meanwhile, weak euro-zone GDP growth will probably weigh on export growth too (24).
  • Denmark’s Nationalbank intervened in the FX market to strengthen the krone for the third month in a row in December (25). The amounts have been relatively small, which suggests that policymakers are more comfortable with this “weakness” in the krone than in the past. Nonetheless, there is a rising chance that the Bank will cut rates by less than the 30bp that we have pencilled in for the ECB this year.

Chart 20: GDP & Economic Sentiment Indicator

Chart 21: Manufacturing PMI & Industrial Production

Chart 22: EC Employment Component &
Employment Growth

Chart 23: Consumer Confidence &
Household Consumption

Chart 24: Danish Exports & Euro-zone GDP (% y/y)

Chart 25: Danish Krone & DNB FX Interventions

Sources: Refinitiv, Capital Economics


Finland

  • Having grown robustly in mid-2019, growth in Finland has weakened in recent months. GDP expanded by 0.7% q/q in Q3 but the monthly trend indicator of output suggests that growth slowed to about 0.3% in Q4 (26). This chimes with hard data from the quarter, which indicate that both retail sales and industrial production growth slowed (27).
  • Looking ahead, the economy is likely to struggle to pick up pace, not least because recent developments in the labour market will weigh on consumption. The unemployment rate was unchanged at 6.7% in November for the twelfth month in a row. Given that business surveys indicate that employment growth will fall to zero in the coming months (28), further falls in the unemployment rate are unlikely.
  • Annual bank lending growth to the private sector has remained solid (29), although the pace has moderated over the past year and surveys are consistent with investment contracting in annual terms (30). Meanwhile, the subdued outlook for growth in Finland’s trade partners over the coming years is likely to prove a headwind for Finnish exporters (31).

Chart 26: Monthly Trend Indicator of Output & GDP

Chart 27: Industrial Production &
Retail Sales (% 3m/3m)

Chart 28: Employment & Manufacturing Hiring Intentions

Chart 29: Bank lending to Non-Financial Corporations (% y/y, Adjusted for Sales & Securitisations)

Chart 30: Firms’ Production Expectations & Investment

Chart 31: GDP Growth in Key Trade Partners &
Finland Exports (% y/y)

Sources: Refinitiv, Capital Economics


Iceland

  • The sharp downturn in the tourism sector is continuing to take a toll on the Icelandic economy. Admittedly, consumer confidence has edged up in recent months and, on the face of it, suggests that annual GDP growth may soon recover to about 2.5% (32).
  • However, with real wage growth close to multi-year lows (33), and payment card data pointing to subdued household consumption growth (34) we suspect that the recovery will be slow. Tourist arrivals fell by 12.6% y/y in December, and the annual growth rate has now been in negative territory for the past 12 months in a row (35). While the Icelandic GDP data are highly erratic, we have pencilled in another quarterly decline in output in Q4 2019.
  • The Central Bank of Iceland left rates at a record low of 3.00% in December and we expect rates to remain on hold until at least the end of 2021. However, given that headline inflation plunged to a 19-month low of 2.0% in December (36), and inflation expectations have fallen sharply over the past year (37), the balance of risks is skewed towards further easing.

Chart 32: Consumer Sentiment & GDP

Chart 33: Wage Growth (% y/y)

Chart 34: Payment Card Turnover & Household Spending

Chart 35: Tourist Arrivals & GDP

Chart 36: CPI Inflation (%)

Chart 37: Inflation Expectations (%)

Sources: Refinitiv, Central Bank of Iceland


Financial Markets

  • Icelandic government bond yields dropped after the weak December inflation data, but yields elsewhere generally rose a bit over the past month (38). We expect most of those yields to end this year slightly lower than where they are now (39). That is primarily because, unlike investors, we think that the SNB and the Riksbank – as well as the ECB – will resort to rate cuts in the coming months (40). The exception is Norway, where we expect bond yields to edge up as the economy fares relatively better.
  • The Norwegian krone has strengthened strongly over the past thirty days (41). Given the different prospects for economic activity and monetary policy in Norway and Sweden, we expect the NOK to outperform the SEK this year. Meanwhile, safe haven demand has boosted the Swiss franc (42), and we think that concerns about its strength will lead to even looser monetary policy.
  • Finally, equities in Switzerland and the Nordics have risen further (43), and we think that they will continue to do so over the next couple of years, albeit more slowly than last year. That said, we think that this will be the case for most other developed-world stock markets, including those in the US.

Chart 38: Changes In Government Bond Yields

(bp, 14th December 2019 to 14th January 2020)

Chart 39: 10-Year Government Bond Yields
(%)

Chart 40: Policy Rates, CE Forecast Vs. Market (%)

Chart 41: Changes In Exchange Rates
(%, 14th December 2019 to 14th January 2020)

Chart 42: Swiss Francs per Euro & SNB Language

Chart 43: Changes In Equity Prices
(%, 14th December 2019 to 14th January 2020)

Sources: Refinitiv, Bloomberg, Capital Economics


Background Data

Chart 44: Current Price GDP
(€bn, 2018, Market Exchange Rates)

Chart 45: GDP Per Capita
(€thsd, 2018, Market Exchange Rates)

Chart 46: Real GDP (% y/y, 2018)

Chart 47: Consumer Prices (EU Measure, % y/y, 2018)

Chart 48: Government Budget Balance
(% of GDP, 2018)

Chart 49: Government Debt
(% of GDP, 2018)

Source: Refinitiv


Andrew Kenningham, Chief Europe Economist, +44 20 7808 4698, andrew.kenningham@capitaleconomics.com
David Oxley, Senior Europe Economist, +44 20 7811 3906, david.oxley@capitaleconomics.com
Melanie Debono, Europe Economist, +44 20 3750 0991, melanie.debono@capitaleconomics.com
Hubert de Barochez, Markets Economist, +44 20 7808 4088, hubert.debarochez@capitaleconomics.com

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