The Swiss franc, a traditional safe haven currency, is experiencing a surge in demand, causing unexpected challenges for Switzerland’s central bank. Global market volatility, fueled in part by U.S. President Donald Trump’s trade policies, has driven investors towards the franc, causing it to appreciate significantly against the U.S. dollar—a 10% increase since the beginning of the year. While this might seem positive, the strengthening franc is creating deflationary pressures within Switzerland.
This appreciation makes imports cheaper, a boon for some economies battling inflation. However, Switzerland is facing the opposite problem: prices are falling too rapidly. May saw Switzerland’s Consumer Price Index fall by 0.1% year-on-year, with imported goods contracting by 2.4%. This marks a return to deflation unseen since the COVID-19 pandemic, a situation Charlotte de Montpellier, senior France and Switzerland economist at ING, attributes largely to the strong franc’s impact on import costs.
This deflationary trend presents a significant challenge to the Swiss National Bank (SNB). The SNB ended a period of negative interest rates in 2022, a policy unpopular with savers and lenders. However, the current situation may force a return to this unpopular measure. ING predicts the SNB will cut its key interest rate by 25 basis points at its next meeting, with further cuts potentially following. A return to negative interest rates before the year’s end is increasingly likely, according to De Montpellier, even potentially reaching -0.25%.
Another tool at the SNB’s disposal is currency intervention – selling francs and buying foreign currencies. However, this strategy carries significant political risk, given the Trump administration’s past labeling of Switzerland as a currency manipulator in 2020. The threat of retaliatory tariffs from the U.S. makes this option less appealing, as the potential economic damage from such tariffs could outweigh the benefits of curbing the franc’s strength. While SNB Chair Martin Schlegel has reported constructive talks with the U.S. on this issue, the risk of being labeled a manipulator again remains a significant deterrent.
Experts like Lily Fang, a professor of finance at INSEAD, believe that the SNB will likely prioritize interest rate cuts before resorting to currency intervention. The Swiss economy’s reliance on international trade, particularly with the U.S., makes the potential consequences of escalating trade tensions a major concern. The SNB faces a delicate balancing act: managing deflationary pressures while navigating the complex political landscape of international trade relations. The coming months will be crucial in determining the SNB’s strategy and the ultimate impact on the Swiss economy.
