With consumer prices falling in Switzerland for the first time in two years, the Swiss National Bank is under fresh pressure to weaken the Swiss franc further to keep the economy from sinking into a recession.
In stark contrast to inflationary pressures elsewhere in Europe, consumer prices fell in Switzerland by 0.1% in October compared to September, while so-called core inflation—which strips out volatile prices such as tobacco and fuel—fell a surprising 0.5%.
The strength of the Swiss franc pushes down prices, both by slowing the general economy through weaker exports and pushing Swiss retailers to cut prices on products imported from the euro zone.
The price figures raise pressure on the SNB to consider new action to weaken the franc, which has become a safe haven currency for investors seeking stability amid the euro zone's fiscal and political woes. In September, the Swiss central bank effectively put a cap on the franc when it said it would "no longer tolerate" the euro falling below 1.20 francs, saying it would intervene heavily to defend that line. Since then, the euro has traded between 1.21 and 1.24 francs. The euro nearly hit parity with the franc in early August.
The euro rose almost 1% to 1.2367 francs on Monday, both on the price data and comments by SNB President Philipp Hildebrand over the weekend in the Swiss press saying he was ready to take "more measures" to weaken the franc, which he still regards as too strong. Those comments, along with Monday's price data, lent fuel to those expecting the SNB to raise its euro-franc floor to 1.30 francs or higher. Economists put a fair value of the euro at 1.35-1.40 francs.
"They've given some very loud warnings in recent days that they're seriously considering it," says Michael Derks, chief currency strategist for foreign-exchange broker FxPro.
The strong franc continues to weigh heavily on an economy that had been growing at a about 3% last year. Exporters are struggling to sell their goods, while industrial companies such as Novartis AG have announced thousands of job cuts this fall. A recent Ernst & Young report found that the franc is beginning to dent Switzerland's popularity as a destination for multinationals seeking a base for regional or global operations. Ursina Kubli, currency strategist with Sarasin, expects Switzerland to suffer a shallow recession this winter, with gross domestic product expanding only 0.6% next year.
But economists generally think the SNB will wait for new leading economic indicators to see how severe the economic slowdown is before deciding whether to test the markets by raising the euro-franc floor. The SNB's bold move to cap the franc has been remarkably successful over the last two months. Foreign exchange reserve figures suggest the bank has barely had to intervene to defend its limit.
Indeed, Monday's price figures help bolster the SNB's rhetoric—and ironically could weaken the franc further without the bank's having to set a new floor. In September, the SNB's threatened to buy "unlimited'' amounts of foreign currency to restrain the franc. Massive intervention by central banks often fails because they need to print huge amounts of currency to fund the move, which in turn fuels inflation. But with prices falling in Switzerland, the SNB could print francs without fear of inflation for a long time, which bolsters the credibility of its threat further, say economists.
As a result, some think the SNB will rely on rhetoric for at least a while longer to weaken the franc, particularly given fresh euro-zone turmoil coming from Greece and Italy.
The tensions in Greece and Italy "complicate the SNB's task," says Mr. Derks. "That didn't prevent them from moving amidst very significant head winds in September, but it'll be harder this time because the market sees them coming."
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