Swiss inflation turns negative, raising likelihood of negative interest rates

Swiss inflation unexpectedly turned negative in May, falling 0.1% year-on-year, the first decline in over four years, increasing pressure on the Swiss National Bank (SNB) to cut interest rates at its upcoming June 19th meeting. Markets are pricing in a high probability of a 25 basis point cut, potentially returning Switzerland to negative interest rates, driven by a strong Swiss franc and falling energy prices. While the SNB declined to comment, economists are divided on the extent of future rate cuts, with some forecasting further easing to maintain inflation within the SNB's 0-2% target range.

Analysis

Swiss consumer prices unexpectedly registered a year-on-year decline of 0.1% in May, the first instance of negative inflation since March 2021 and a development that places inflation outside the Swiss National Bank's (SNB) 0-2% target range. This outcome significantly intensifies pressure on the SNB to implement an interest rate cut at its upcoming June 19th meeting. Market participants widely anticipate a rate reduction, assigning a 69% probability to a cut from the current 0.25% to 0%, and a notable 31% probability of a decrease to -0.25%, which would reintroduce negative interest rates in Switzerland. While the SNB refrained from commenting on the specific data, Chairman Martin Schlegel has previously indicated a focus on medium-term inflation trends and a willingness to consider negative rates if necessary. Economists offer varied perspectives on the extent of future easing; ING economist Charlotte de Montpellier forecasts a 25 basis point cut in June followed by another in September, attributing the disinflation primarily to the strong Swiss franc, which lowered imported goods prices by 2.4%, and a significant drop in energy prices, suggesting rates will likely re-enter negative territory to manage inflation expectations. Economists at UBS and EFG Bank also project a 25 basis point cut in June. Conversely, Rudolf Minsch from economiesuisse anticipates a single 25 basis point reduction in either June or September, followed by a pause, citing persistent positive domestic inflation and current oil price levels as factors providing the SNB with more flexibility before resorting to negative rates.

Key Decisions for Investors

• Investors should anticipate heightened Swiss franc volatility and potential weakness leading up to and following the SNB's June 19th policy meeting, given the strong likelihood of a rate cut.
• Portfolio allocations exposed to Swiss assets may warrant review, considering the increased probability of negative interest rates in Switzerland and the potential impact on currency valuations and yield-sensitive investments.
• Monitor subsequent Swiss inflation data and SNB communications closely, as divergent economist outlooks on the depth and duration of the easing cycle beyond June suggest ongoing uncertainty for monetary policy direction.