In December, the Swiss central bank cut interest rates by a surprise 50 basis points to 0.5 per cent. The move raised the spectre of negative interest rates – something that featured heavily both in the years before and then during the Covid pandemic.
Hindsight shows that in 2015, Switzerland’s negative interest rate policy made economic sense – though it also seems clear that they were kept too low for too long. Now, however, there is no economic justification for rates to go negative again. That should be a relief for investors scarred by those long years of scratching around for yield. And given that Switzerland is something of a canary in the coalmine for monetary policy worldwide, what it does could have important ramifications for investors wherever they invest.
NIRP is (sometimes) useful...
The goal of a negative interest rate policy (NIRP) is to ensure an economy doesn’t slump into deflation once its central bank has run out of road in standard monetary policy. That’s to say, when interest rates can’t be cut any further, because they’ve already fallen to zero. Deflation itself has the pernicious effect of making consumers hold off on purchases because they expect goods and services to be cheaper next week, next month, or next year. The ensuing slump in demand then causes investment to drop as well. At the same time, deflation causes the real value of debts to rise, potentially triggering defaults which then depress demand and investment further. A vicious cycle, in other words.
Pushing rates into negative territory combats deflation by forcing those hoarding money into spending it, helping to lift demand and thereby encouraging investment. At the same time, sub-zero rates drive down the value of the domestic currency, which also pushes up inflation, helping to put an end to the deflationary episode. How far below zero rates can go is limited – at some point, negative rates start to undermine their own objectives.
But even when NIRP works, it comes with side effects. It can inflate asset prices, particularly in housing and credit markets, to bubble territory, which heightens financial vulnerability. The policy can also encourage excessive risk-taking behaviour by households and companies, leading to bad debts and weaker bank balance sheets.
In Switzerland’s case, negative rates post-2015 helped push up inflation expectations, boosted bank lending and helped to keep a lid on the Swiss franc’s appreciation. What it didn’t do was to halt flows of capital into the country, driven by Switzerland’s status as a safe haven – which was why NIRP didn’t drive the currency’s value down substantially and why it needed to be supplemented by official intervention in the foreign exchange markets.
Our analysis based on our own modified Taylor Rule The Taylor Rule states that nominal base rates should be close to the rate of nominal GDP growth plus or minus a coefficient that measures how far inflation is from the central bank’s target and how growth is faring relative to its long-term trend. The modified rule takes a nonlinear, semi-parametric approach, factoring in currency fluctuations and for the two-way interaction between exchange rates and inflation.shows that it was indeed optimal for the Swiss National Bank (SNB) to cut rates to -0.75 per cent in 2015. But it also shows that NIRP should have ended in 2017, whereas the SNB persisted with negative rates until 2022.
Swiss National Bank policy rate vs modified Taylor Rule fair value, %
Source: Pictet Asset Manaement, CEIC, Refinitiv. Data covering period 01.10.1989 to 01.02.2025.
...but not now
Using the same Taylor Rule analysis, we find that while it makes sense for the SNB to reduce rates towards zero over the coming months, we also don’t expect there to be any need for negative rates. The SNB should still be able to meet its definition of price stability – which is an inflation rate of between 0 and 2 per cent – while also maintaining economic growth at near potential.
One of the central bank’s biggest challenges is the relentless upward pressure on the Swiss franc. Given this, the SNB should structure an exchange rate policy around a basket of currencies made up of Switzerland’s main trading partners. It could take the form of a crawling peg within an exchange rate band, such as that operated by the Monetary Authority of Singapore.
Negative interest rates have a function, but they should be used very sparingly and only in the appropriate circumstances. We can’t see them becoming necessary for Switzerland in the foreseeable future, which is likely to limit the upside for both Swiss bonds and equities.
