“Negative interest rates may help address the dilemma the SNB faces: low interest rates are necessary to defend the floor but fuel the housing and mortgage markets,” the IMF said in a report today, following its annual Article IV consultation.
Switzerland is in the midst of its strongest housing boom in two decades, fueled in part by the SNB’s loose monetary policy that has made taking on debt inexpensive. The central bank has held its benchmark interest rate at zero since August 2011 and in September of that year capped the franc at 1.20 per euro to shield the economy from the crisis in the neighboring euro region.
Should the franc face another bout of steep appreciation pressure, the SNB could implement a charge on the excess deposits commercial banks hold with the central bank, the IMF said in March. The SNB has repeatedly said it would take further steps if necessary, and Alternate Board Member Thomas Moser said at the time negative rates were indeed an option.
The franc fell to a four-month low against the euro after the report was published, depreciating as much as 0.6 percent to 1.2530 per euro. It was trading at 1.2483 at 5:40 p.m. in Zurich. Against the dollar the franc traded at 96.68 centimes.
Quitting the cap of 1.20 per euro was still “premature,” the IMF said, given the risk of another bout of appreciation pressure. “Once a recovery takes hold, if inflation threatens to move above comfortable levels, the SNB should return to a free float,” it said.
The SNB forecasts consumer prices will fall 0.2 percent for this year and the economy will grow as much as 1.5 percent and it sees no breach of its 2 percent price stability threshold in the next three years. Board Member Fritz Zurbruegg said in an interview last week that the cap will be in place until the risk of deflation recedes.
The central bank spent 188 billion francs ($194 billion) last year defending the cap and holds an amount of foreign currencies equal to about three quarters of annual economic output. The bulk of that is held in euros, and about a quarter in dollars.
Should investor demand diminish for assets perceived as safe, the SNB could begin drawing down its currency holdings, the IMF said.
“The SNB should begin to gradually reduce its holdings of foreign-exchange reserves rather than allow the exchange rate to move significantly above the floor,” it said.
If negative rates were implemented, banks might pass the increased cost of funding on to clients in the form of higher mortgage rates and thereby limit credit growth, according to the IMF report. Lenders might also pass on the higher cost to depositors, which could impede financial intermediation, it said.
Still, given “very low” activity on the Swiss interbank market, the drawbacks of negative rates in Switzerland may be less severe than in other countries, the IMF said.
In a bid to thwart risky lending, the government in February ordered banks to hold additional capital as a buffer. The measure, implemented at the behest of the SNB, takes effect from Sept. 30. Zurbruegg said last week that it was still too early to judge the buffer’s effect.
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