Afternoon analysis 31.08.2015

The SNB chief speech in Jackson Hole – Swiss franc is overvalued. Solid data from Germany and slightly higher inflation in the eurozone. The zloty remains stable in the afternoon.

The Swiss franc is overvalued

The main topic during the Jackson Hole meetings was inflation. Issues discussed by Thomas Jordan, the SNB chief, were also touching consumer prices. However, the Swiss central banker was also arguing about how hard it is to control the CPI in a small open economy.

The case is especially important during the post crisis period, after 2008. During that time, the appreciation of the local currency caused the prices to not move at all for 7 years. Thomas Jordan repeated many times that the franc is “overvalued” and “significantly overvalued”. There is, of course, the main question. By how much?

The single number wasn't clearly articulated. We can, however, assume it by analyzing one of the charts from Jordan’s materials. It shows the real effective exchange rate (REER) of the CHF for the last 40 years.

Real and nominal Swiss franc rate to 24 largest trading partners

• Source: Kansas Fed
• Dark line - nominal rate of the franc to the basket consisting of currencies of Switzerland's 24 trading partners. Bright line - real rate of the franc to the basket consisting of currencies of Switzerland's 24 trading partners. Exit level to value of 100 in January 1999.

The REER is one of the best measures of currency value and the benchmark whether the currency is under or overvalued. In that case, the CHF value is compared to the basket of 24 currencies of Switzerland’s main trading partners (grey line). The black line adds additionally the difference between Swiss inflation and other countries consumer prices. The only measure which is not included in the chart is competitiveness differences between economies.

Thomas Jordan wanted to show that the REER has never been as deviated from the balance levels as it is now. His suggestion is clear – it has to be corrected some time and by some amount. But whether it is going to be 10 or more than 20 percent remains an open question.

German and the eurozone data

Fairly good data was published today from Germany. The retail sales rose 3.3% y/y while economists expectations were close to a 1.7% gain. This may confirm that consumer spending in the largest EU economy returns to moderate growth. The 12-month moving average rose to 2.1% which is the best result since mid 2011.

Both the headline and core inflation from the eurozone were also higher. The difference in both cases was, however, only 0.1 of a percentage point and it should not have a significant impact on the common currency before Thursday's ECB meeting.