Breakthrough on the franc market (Daily analysis 20.05.2022)

This week the franc is definitely the strongest of the main currencies. It has been gaining the strongest against the dollar or the euro since the ill-fated January 2015. There are increasing signs that the franc's weakness should be put between fairy tales.

In recent months, the hierarchy in the quotations of the main currencies has largely been determined by the willingness of individual central banks to raise interest rates. This is why the dollar has led the way and been the strongest on global markets for over 20 years. On the other hand, the franc, which invariably enjoys a reputation as a safe haven, attracted attention due to the outbreak of war in Ukraine, falls on global stock markets (e.g. the S&P 500 index fell by almost 20% this year) and the broadly defined economic problems of the eurozone. As usual: the worse things happen in the eurozone, the more expensive the franc becomes.

However, the Swiss currency has lacked advantages in the monetary policy arena. Still, differences in interest rates between individual economies and their changes are a universal and most important determinant of the attractiveness of a given currency. For years, the Bank of Japan has been perceived as the country least likely to tighten policy. Not without reason: the last time interest rates were raised was in 2007, before the outbreak of the Global Financial Crisis, and since 2015 the cost of money has been -75 basis points. However, everything is beginning to indicate that the SNB chairman is writing himself off as a party of marauders in raising rates, becoming the water for the franc's mill and the source of another display of its strength.

Investors assumed that the Swiss National Bank was keeping two steps behind the European Central Bank - mirroring its moves with some delay. In the current situation, with the ECB likely to raise rates this summer, and because until recently, it was expected that the SNB would not have time to start this year, the latest statements by Governor Thomas Jordan lead us to believe otherwise. The inflation rate in April reached 2.5% year-on-year. In comparison with the eurozone index (almost 7.5% year-on-year), this is a very low value. However, the average inflation level for the whole year will exceed the inflation target of 2%. Given the specific nature of this small economy, this is enough to encourage the central bank to take action. In addition, price pressures in Switzerland have been at their strongest since 2008. Roughly speaking, we can conclude that the last time rates were raised, they were raised with similar price dynamics.

The SNB has repeatedly complained about the strength of the franc. It did not stop at words: over the years, the equivalent of almost half a trillion francs was used for currency interventions aimed at halting excessive, undesired appreciation. The idea that the SNB would follow the ECB's actions with a considerable delay was also inspired: if the Swiss hikes had started earlier, this would have been a premise for strengthening the franc against the euro. And this was something to be avoided as much as possible. As the inflation risk is now coming into the spotlight, one can assume that the determination to weaken the currency and support the EUR/CHF at higher levels has clearly weakened.

To sum up: interest rates will rise in Switzerland. The total scale of the increases is expected to be 75 basis points. The monetary authorities want to take advantage of the situation (accelerating inflation and interest rate increases) to escape from the negative interest rates that have been maintained for many years. The profile of inflation and its prospect of slowing down do not indicate a need for a much more aggressive cycle. This means that it is likely to start in September and end as early as March.

The second conclusion is that a much weaker franc should be a thing to forget. The Swiss monetary authorities' consent for the franc to remain strong and the recent turn in attitude radically reduce the likelihood that the EUR/CHF will rise to 1.10 within a few quarters.