Market Insights, June 7, 2022

Switzerland is often viewed as an expensive island in the middle of Europe. The high standard of living often leads companies to ramp up their prices more here. Unsurprisingly, Switzerland regularly ranks first in the Big Mac index, which compares the price of the famous burger around the world.

However, there has been no inflation in this costly country for over a decade. And Switzerland has largely been spared by the spike in inflation in recent months, although we are now starting to see an increase in prices of goods and services. Despite this recent uptick, Swiss prices are rising at less than half the eurozone rate: consumer prices in Switzerland are up by less than 3% year on year, compared with 7% for the eurozone. Core inflation, which excludes volatile components like energy and food prices, is also well below the EU rate, at 1.7% versus 3.5%. So far, wage growth has been moderate, which means there is less risk of any second-round effects.

But the latest statements from the Swiss National Bank’s (SNB) Governing Board suggest that it is just as nervous as the European Central Bank (ECB) is. In recent weeks, SNB Chairman Thomas Jordan and his colleague Andréa Maechler have begun laying the groundwork for monetary policy tightening. We were surprised by this change in tone, not only because inflation is lower in Switzerland, but above all because the Swiss franc has gained ground against the euro recently. And it could be pushed higher as investors flock to the franc – Europe’s safe-haven currency – amid the ongoing geopolitical uncertainty.

As things stand, a rate hike by the SNB could bring an end to Switzerland’s policy of negative rates, an urgent measure adopted in 2015, in the wake of the eurozone’s sovereign debt crisis, and that has remained in place ever since. At a time when other major central banks – which should soon include the ECB – are tightening their monetary policy, this could be a unique opportunity for the SNB to turn the page on negative rates before the end of the year.

Most economists are now bearish on the eurozone economy, which has been hit particularly hard as a result of the region’s proximity to the war in Ukraine. Some observers are even forecasting a recession coupled with high inflation.

Unlike in the United States, where inflation is showing signs of easing, inflation is still increasing in Europe, with the impact of soaring food and energy prices compounded by the weak euro. Christine Lagarde’s recent statements have confirmed market expectations: we should see an initial rate hike in the eurozone in July. But it won’t be an easy task for the ECB, as it will have to raise rates at a time when the economy is slowing, increasing the risk of a policy error.

For the moment, consumer spending seems to be holding up well, but consumer confidence has crumbled, which is cause for concern. Household spending is likely to decline as the cost of living increases, but this probably won’t happen until early autumn – tourism is expected to bounce back sharply this summer and should shore up consumer spending in the short term. What’s more, Europe is an export economy and will continue to be buoyed by solid growth in the US and the nascent recovery in China. That should to some extent offset the slowdown in consumer spending.

Inflation is currently less structural in Europe than in the US, as it is not being driven by wage growth. In our view, it would take the rationing of gas supplies, amid heightened tensions with Russia, to plunge Europe into a recession.