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Monetary policy decisions 2007

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On 18 February 2008, the Governing Board of the Swiss National Bank submitted its 2006 Accountability Report to the Federal Assembly in accordance with art. 7 para. 2 of the National Bank Act. The following Accountability Report is submitted to the Federal Council and the General Meeting of Shareholders for information purposes only, and does not require their approval.

Interest rate decisions

Four times a year, in March, June, September and December, the SNB’s Governing Board conducts an assessment of the monetary policy situation. Each of these in-depth assessments results in an interest rate decision. In addition, if circumstances so require, the Governing Board also adjusts the target range for the three-month Libor in Swiss francs between regular assessment dates. In 2007, however, this was not the case.

Monetary policy challenges in 2007

In the first half of 2007, the SNB continued the policy of normalising the level of interest rates which it has been pursuing for the past three years. Consequently, it lifted the Libor target range in two steps to bring the interest rate to a level that was in line with the strength of the economy and that would ensure price stability in the medium term.

In the second half of the year, the SNB was operating in a new environment. Management of monetary conditions consisted of ensuring, on the one hand, that the healthy state of the economy did not jeopardise price stability in the medium term, and, on the other hand, that the turbulence on the financial markets did not result in a liquidity shortage. Consequently, the aim of monetary policy was to relax monetary conditions sufficiently to ensure that interbank market nervousness did not jeopardise the growth and stability of the Swiss economy, but to do so without any relaxation of vigilance in the matter of price stability.

Monetary policy in 2007 facing numerous risks…

As in previous years, monetary policy in 2007 was exposed to numerous risks in the short, medium and long term. The SNB regularly evaluates the probability of such risks, their consequences for the economy and their implications for monetary policy.

…in the short term risks…

Although the vagaries of oil prices represented a major risk to the economy and to price stability throughout 2007, the principal risk capable of dampening economic activity in the second part of the year was the crisis on the credit market, which deeply shook the financial markets and rocked the banking world. Although the volatility in energy prices did not cause the SNB to adopt any particular measures, the fear that money markets might dry up, however, encouraged it to relax monetary conditions in the second half of 2007.

…in the medium term…

Uncertainties with respect to the outlook for the global and Swiss economies remain the principal risks in the medium term. Although the European and Swiss economies grew in line with expectations in 2007, in the second half of the year there were an increasing number of indications of a considerable slowdown in the United States as a result of the substantial corrections on the real estate and financial markets. In addition, the weakness of the Swiss franc against the euro constituted an additional risk to price stability throughout the year.

…and in the long term

The outlook for inflation in the long term would have deteriorated if the SNB had not maintained the normalisation of its monetary policy. Thus, raising interest rates in 2007 was necessary if favourable perspectives for price stability were to be maintained.

Quarterly assessment of 15 March

As at each monetary policy assessment, the SNB bases its inflation forecast on the global economic scenario it regards as most likely. The economic trends that had emerged in the course of 2006 – a slowdown in the US and sustained growth in Europe – were confirmed at the first quarterly assessment of 2007. Consequently, the SNB predicted growth for 2007 of 2.8% in the US and 2.3% in Europe, and for 2008 of 3.1% in the US and 2.2% in Europe. It also expected that the decline in oil prices would continue to dampen inflation in the months following the assessment.

At the time of the assessment, the business cycle in Switzerland was solidly established. During the course of the following quarters, most components of domestic demand as well as exports would further consolidate growth. Moreover, the healthy economy would stimulate the labour market and promote a further decline in unemployment. Consequently, the National Bank continued to forecast GDP growth of approximately 2% for 2007.

At the time of the quarterly assessment, the Swiss franc had strengthened a little against the euro, following a period of weakness whose effect on inflation had not been significant.

In this context, the evaluation of the inflation outlook at the time of the assessment involved a greater level of uncertainty. Although foreign competition and the opening up of the labour market continued moderating price increases, there was a risk that, to an increasing extent, the rise in production costs would be passed on to prices due to the high level of capacity utilisation. Consequently, the Governing Board decided to lift the Libor target range by 25 basis points, with the new range being set at 1.75–2.75%.

According to the graph shown at the end of the assessment, the path of the inflation forecast based on an unchanged Libor of 2.25% was below that of December 2006 for a large part of 2007, due in particular to the drop in oil prices. The acceleration that followed, in which the new forecast overtook that of December, was more marked than previously, due to the weakening in the Swiss franc, which neutralised the impact of the increase in the interest rate. For 2009, the path of the forecast again fell below the December forecast, as the effects of the higher interest rate once again predominated. Expected inflation amounted to 0.5% for 2007, 1.4% for 2008 and 1.6% for 2009. Even though inflationary forces were muted overall, they picked up slightly at the end of the forecast period.

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Quarterly assessment of 14 June

At the time of the June assessment, the US economy, although satisfactory, was a little less strong than expected. Consequently, the SNB reduced its growth forecasts for the US, setting them at 2.2% for 2007 and 3% for 2008. By contrast, the European economy was better than previously expected. The forecast for 2007 was lifted to 2.6% while that for 2008 remained unchanged at 2.2%.

The Swiss economy was in good shape at the time of the assessment, due in particular to demand from neighbouring countries and exchange rate developments.  In addition, since the March assessment, the strength of the economy had continued to support improvements in the labour market. Consequently, unemployment numbers had declined further, with the rate slipping below 3%. As a result, the SNB forecast GDP growth close to 2.5% for 2007.

In the foreign exchange market, the Swiss franc had continued giving ground to the euro and appreciating against the US dollar. In export-weighted terms, it had depreciated by 1.7%. This relaxation in monetary conditions continued to work against the effects of Libor increases and threatened to stimulate inflationary pressures in an economy operating at a high level of capacity utilisation.

In this situation, price stability was exposed to several risks, the first of which was the high price of oil. The second risk was that global demand was growing at too rapid a pace in relation to the development in production capacity. The third risk was related to the decline in the value of the Swiss franc against the euro. To ensure that medium-term price stability was not jeopardised by the strong economy, the Governing Board decided to raise the Libor target range once again by 25 basis points, thereby taking it to 2.00–3.00%.

On the assumption of an unchanged Libor of 2.50%, the published forecast put average annual inflation at 0.8% for 2007, 1.5% for 2008 and 1.7% for 2009. The combined effect of high oil prices, strong economic developments and a weakening Swiss franc resulted in a deterioration in the inflation outlook during the course of the months following the assessment. However, from mid-2008, inflation moved up to a level slightly above that forecast three months previously, approaching 2% at the end of the forecast period.

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Quarterly assessment of 13 September

The international environment at the time of the September assessment was dominated by the mortgage loans crisis in the US, a major correction on the stock market and the liquidity shortfalls on the money market. For the time being, the global economy did not appear to have been affected. Growth in the US economy was only very slightly weaker than expected, but the risks of a slowdown at the end of 2007 had risen. Moreover, after having fallen back between mid-July and mid-August, oil prices were heading upwards again.

In Switzerland, GDP had grown strongly in the first half of the year and employment was still improving. Consequently, capacity utilisation would remain high. The SNB, therefore, retained its GDP growth estimate for 2007 close to 2.5%, subject to any unexpected moderating effect arising from the uncertainties related to the financial markets.

As against the previous assessment, however, the inflation outlook had worsened somewhat. Oil price developments constituted the main risk. In addition, capacity utilisation remained high and the Swiss franc was still relatively weak. Nevertheless, it was possible that certain factors, such as a possible economic slowdown attributable to the turmoil on the financial markets, might limit the inflationary risks. In the meantime, since the turmoil on the money market had lifted the Libor from 2.5% to 2.9%, the tightening in monetary conditions was considered excessive with respect to the outlook for inflation. In this situation, the Governing Board decided in favour of relaxing money market conditions by bringing the Libor back to 2.75% while simultaneously lifting the target range by 25 basis points to 2.25–3.25%. From this assessment onwards, the SNB aimed for a Libor of around 2.75%.

Despite the higher level of the Libor, the inflation forecast published in September was almost identical to that of June. On the assumption of an unchanged Libor of 2.75%, the SNB forecast average annual inflation of 0.6% for 2007, 1.5% for 2008 and 1.8% for 2009. Inflation rose to the first quarter of 2008 and then flattened slightly from the second quarter onwards. In essence, this forecast was based on recent oil price developments. From mid-2008, a slight increase in inflation was expected, with figures even reaching 2% at the end of the forecast period.

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Quarterly assessment of 13 December

For the final assessment of the year, the SNB assumed that US economic growth – affected simultaneously by the unfavourable developments on the real estate and credit markets and by the rise in oil prices – could weaken in 2008 (forecast: 2.4%). At the time of the assessment, Europe did not appear much affected by the rise in the euro and the turmoil on the financial markets, and its growth outlook was likely to remain good, even though the SNB adjusted it slightly downwards for 2008 (forecast: 2%).

Swiss growth was strong in the third quarter, with GDP growing at an annualised rate of 3.3%. Simultaneously, in the months preceding the assessment, employment had continued increasing in practically all sectors. As a result of these developments, the growth outlook remained good for the quarters ahead, and therefore the SNB was forecasting GDP growth of some 2% in 2008, a lower figure than that recorded in 2007. This relaxation in the pace of economic activity should allow for some reduction in the level of capacity utilisation.

The inflation outlook remained good, even though it encompassed even more uncertainties than the previous assessment. Although price stability would be supported by the expected slowdown in the growth of the Swiss economy and the reduction in the rate of increase of the monetary aggregates, there were other elements capable of disturbing this stability. Examples of such inflationary factors were the rise in oil prices, should it persist, as well as the continued weakening in the Swiss franc. In this uncertain situation, the Governing Board decided to retain the Libor target range at 2.25–3.25%, aiming for a Libor of 2.75%.

On the assumption of an unchanged Libor of 2.75%, the inflation forecast indicated a surge in inflation in the first half of 2008. This advance, in which expected inflation temporarily rose above 2%, was mainly due to the increase in the price of oil. From mid-2008 to the end of the forecast period, however, inflation settled at around 1.5%. The sudden correction to the forecast in the middle of the year was due to a baseline effect, and the downturn of the path at the end of the forecasting period was to be seen within the context of the expected slowdown in the international economy.

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