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Monetary policy decisions 2008

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On 4 March 2009, the Governing Board of the Swiss National Bank submitted its accountability report for 2008 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

The SNB’s Governing Board conducts an assessment of the monetary policy situation in March, June, September and December. Each of these indepth assessments results in an interest rate decision. If circumstances so require, the Governing Board may adjust the target range for the three-month Libor in Swiss francs between regular assessment dates. In 2008, this occurred three times.

Monetary policy challenges in 2008

The extreme uncertainty on how the main macroeconomic and financial variables would develop was a challenge for monetary policy throughout the year. While the increasing price of energy and its impact on inflation and the economy held the attention of the National Bank in the first half of the year, it focused its efforts at the end of the year on the intensification of the financial crisis and its effects on the real economy.

Rise in oil prices

For the first time since the new monetary policy strategy was implemented in 2000, inflation – boosted by rising oil and commodity prices – exceeded the 2% ceiling, which the SNB defines as the upper bound of price stability. Inflation remained above this level during the first ten months of 2008. Nevertheless, the energy price developments did not require a response from the National Bank. On the one hand, it would have been inappropriate to take action against short-term inflationary pressure and, on the other, a tightening of the monetary reins could have exacerbated the moderating effects that high oil prices were already having on the economy.

Intensification of financial crisis

In the second half of the year, the financial crisis spread to the rest of the world, with Switzerland being affected to a lesser extent. This changed the situation fundamentally. Whereas oil prices and inflationary pressure no longer constituted a medium or long-term threat, precise evaluation of the effects of the financial crisis on the Swiss economy constituted the main difficulty for the SNB. The challenge was to create an environment that would alleviate the slowdown, while maintaining price stability in the medium and long term.

Quarterly assessment of 13 March

In the months prior to the first assessment of the year, the international economy had deteriorated further and the impact of the US mortgage crisis had become increasingly severe. At its March assessment, the SNB assumed that the economic slowdown would be stronger than previously anticipated in both the US (2008: 1.5%; 2009: 2.4%) and Europe (2008: 1.7%; 2009: 2.0%). Moreover, it forecast higher inflation in the advanced countries due to the fact that oil prices were withstanding the slowdown in the global economy.

At the time of the March assessment, the Swiss economy was only slightly affected by the decline in growth in its main export markets. Supported by strong domestic demand, GDP had surged by an annualised 4.2% in the fourth quarter of 2007 on the previous period, taking annual growth in 2007 to more than 3%. Moreover, the labour market continued improving and unemployment fell to about 2.5%. The SNB expected that employment would continue to rise in the first half of 2008. However, it assumed that the Swiss economy would move into a slower phase as a result of the deterioration in the international economy. Consequently, it revised its GDP growth forecast downwards to between 1.5% and 2% for 2008.

In the months prior to the assessment, the Swiss franc had appreciated. Taking into account the inflation differential between Switzerland and its trading partners, the real effective Swiss franc had recovered its level of 2006. Moreover, M3 had registered moderate growth, giving rise to monetary conditions compatible with a middling level of inflation in the medium and long term.

Thus, although inflation risks had been revised upwards for the year under review, they were more limited for the years that followed. On 13 March 2008, given the deterioration in the economic outlook and the expected reduction in inflation in the medium term, the Governing Board decided to leave the target range for the Libor unchanged at 2.25–3.25%.

The inflation forecast published at the time of the assessment was based on an unchanged Libor of 2.75%. With an inflation forecast of 2% for 2008, the path of the inflation forecast curve published in March was above that of the December forecast. However, for 2009 and 2010, the path of the new inflation forecast curve was slightly lower, reaching 1.4% by the end of the forecast period. The increase in the inflation forecast for 2008 was due, in particular, to the higher level of capacity utilisation, which made it easier to pass on costs, as well as to oil and commodity prices and the lagged effects of the Swiss franc weakness in 2007. The improvement in the medium and long-term inflation outlook was essentially due to the fact that the economy was now expected to weaken at a faster rate than had been anticipated in December.

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Quarterly assessment of 19 June

At the time of the June assessment, growth in the international economy was varied but there was no major slowdown. The impact of the crisis in the financial sector on the rest of the economy had been felt less severely and more slowly than had been expected. Moreover, the healthy state of the world economy continued to fuel oil prices, and this pushed up global inflation. Against this background, the SNB made a slight downward revision to its growth forecasts for the US and Europe in 2008 and 2009.

In Switzerland, economic activity had slackened considerably in the early months of 2008. GDP had advanced by only 1.3%, in annualised terms, in the first quarter. The slowdown was partly attributable to after-effects of the monetary policy normalisation implemented over a period of several years. It was magnified by the weakening of exports and a drop in the volume of stock market transactions, curbing added value in the banking sector. It was likely that high oil prices and the uncertainties linked to the US real estate market would continue to hold back economic activity in the quarters ahead. Nevertheless, the SNB still forecast GDP growth of between 1.5% and 2% for 2008.

The Swiss franc had depreciated against the currencies of Switzerland’s most important trading partners in the months prior to the June assessment, thereby partially reversing the appreciation that had occurred at the beginning of the year. M1 and M2, which had dropped in the previous quarters, were more or less stable at the time of the assessment. M3 continued growing moderately. With the financial crisis persisting, close attention was being paid to the state of the credit market. The rate of growth of mortgage lending was still declining, due to the normalisation of monetary policy, and amounted to 3.3% at the time of the assessment. Since banks had not tightened lending conditions to households or companies in the months preceding the assessment, the rate of growth of other lending remained high.

Although inflation had been above 2% since December 2007, the SNB regarded this situation as temporary and anticipated that the forecast downturn in the economy would have a moderating influence on inflationary pressures. Consequently, on 19 June 2008, the Governing Board decided to leave the target range for the Libor unchanged at 2.25–3.25%.

The inflation forecast published at the time of the assessment was based on an unchanged Libor of 2.75%. The level of inflation was expected to remain above 2% until the first quarter of 2009. What is more, the anticipated inflation exhibited a degree of tenaciousness attributable to the combination of rising oil prices and a robust economy. However, the forecast showed that the expected downturn in the economy, the decline in the rate of capacity utilisation and a base effect for oil prices would all contribute to a fall in future inflation. Inflation in 2008 was expected to amount to 2.7%. According to the forecast, it would fall back to 1.7% in 2009 and to 1.3% in 2010.

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Quarterly assessment of 18 September

In its September evaluation of the situation, the SNB revised its forecast for the international economy for two reasons. First, it assumed that the economy would be weaker for the rest of 2008 in both the US (1.8%) and Europe (1.3%). Economic recovery would thus be delayed in the years ahead in the US (2009: 1.3%; 2010: 2.8%) and Europe (2009: 0.9%; 2010: 2.1%). Second, the National Bank expected a less substantial decline in US and European inflation in 2009 than it had anticipated.

Although it had fallen off slightly, growth in the Swiss economy in the first half of the year was still relatively strong despite the deterioration in the world economy. However, the slowdown was likely to continue in the months ahead, particularly due to the decline in financial transactions, manufacturing and construction. In most cases, capacity utilisation had been above historical norms, and the downturn therefore represented a decline from a high level of activity. Thus, the SNB maintained its forecast of GDP growth between 1.5% and 2% for 2008.

Monetary conditions were almost unchanged from the situation at the June assessment. Despite the turmoil in the financial markets, the Swiss franc had remained relatively stable. The rate of growth of mortgage lending was comparable to that recorded at the previous assessment. The financial crisis had not had any impact on other lending. The monetary aggregates were growing at moderate or even negative rates, which meant that low inflation rates could be expected in the medium and long term.

Recorded inflation at the time of the assessment, which was above 2%, was expected to be only temporary in nature, since the forecast slowdown in the economy would have a moderating effect on prices. Consequently, medium and long-term price stability was not compromised. In this situation, the Governing Board decided, on 18 September 2008, to leave the target range for the Libor unchanged at 2.25–3.25%.

According to the published inflation forecast, assuming that the Libor remained unchanged at 2.75%, inflation would reach 2.7% in 2008 and then ease back to 1.9% in 2009 and 1.3% in 2010 as a result of the economic downturn and the stabilisation of oil prices. The forecast indicated that inflation would be slightly more tenacious in the short term and would exceed the 2% level until the second quarter of 2009. In the subsequent quarters, the anticipated inflation would return to a level compatible with medium-term price stability.

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Extraordinary decision of 8 October

During the weeks following the September decision, the international financial crisis took on a greater order of magnitude. This was particularly visible in the rise in risk premia which led to a surge in the Libor from 2.75% to over 3%. Moreover, the financial turmoil had a considerable impact on the global economy. Consequently, the slowdown in economic activity in the US and Europe was more substantial than had been expected at the time of the September assessment.

It was clear that the Swiss economy would be affected by these developments – particularly its export sector. The SNB therefore assumed that growth in 2009 would be below the level expected at the previous assessment. At the same time, however, given the economic deterioration and the substantial drop in oil prices, the improvement in the inflation outlook permitted an immediate relaxation of the monetary reins.

Consequently, on 8 October 2008, the SNB decided to relax its monetary policy in coordination with several other central banks (Bank of Canada, Bank of England, European Central Bank, US Federal Reserve and Swedish Riksbank, with the support of the Bank of Japan), and to bring about a fall in money market rates by initiating a 50 basis point decline in the Libor from 3% – which was about its level at the time of the decision – to 2.5%. In order to achieve this, the target range was set at 2.0–3.0%.

Extraordinary decision of 6 November

In early November, the international economic outlook was still worsening more dramatically than had been expected. At another monetary policy assessment, the SNB assumed that this deterioration would result in negative growth for Switzerland in the upcoming quarters. The slowdown in economic activity, falling oil prices and the appreciation of the Swiss franc at the time of the decision were accentuating the expected drop in inflation.

Consequently, on 6 November 2008, the Governing Board decided to lower the Libor target range by 50 basis points, setting it at 1.5–2.5%.

Extraordinary decision of 20 November

By the end of November, it was clear that price stability was being reestablished more rapidly than expected, due to plunging oil and commodity prices. Moreover, the international economy had once again deteriorated sharply in the weeks preceding the decision, and this implied a high risk of substantial weakening in the Swiss economy in 2009.

In these circumstances, on 20 November 2008, the Governing Board decided to lower the Libor target range by 100 basis points, with the new range being set at 0.5–1.5%. With this drop of a magnitude unprecedented since the introduction of the new monetary policy strategy in 2000, the SNB clearly demonstrated its commitment to an easing in the money market. It also showed that, in the difficult situation facing the Swiss economy, monetary policy needed to be clearly expansionary.

Quarterly assessment of 11 December

At the time of the final assessment of the year, the international situation had altered radically as compared to the September assessment. The financial crisis had now spread to the rest of the economy and the advanced economies had all moved into recession more or less simultaneously. In addition, with the drop in global demand, prices of oil, commodities and food had collapsed. This gave rise to further worsening in the growth outlook for the US and Europe.

The SNB expected that the Swiss economy would be severely affected by these developments. In the upcoming quarters, all the components of demand apart from consumption were likely to fall. The slump in foreign demand would probably hit Swiss exports, and especially exports of capital goods. Investment, moreover, was likely to be the component of demand that would drop most markedly. Consumption, however, would probably continue advancing, although at a slower pace, supported by retreating inflation rates, in particular. Consequently, the SNB forecast GDP growth for 2009 of between –0.5% and –1%.

The rate of growth of mortgage lending remained at a level comparable to that recorded at the previous assessment. Other lending was not affected by the financial crisis at the time of the assessment. At that stage, there was therefore no reason to speak of a credit crunch. In the wake of the drop in interest rates, growth in the monetary aggregates had accelerated, but there had been no increase in the risk of inflation since the strong demand for liquidity was fundamentally attributable to precautionary measures.

Despite the three inflation rate reductions decided upon in October and November, inflation risks had largely dissipated as a result of the deterioration in the economic outlook and the slump in oil prices. It was even possible that negative rates of inflation would be experienced for some months of 2009. In these circumstances, on 11 December 2008, the Governing Board decided to lower the Libor target range by an additional 50 basis points, with the new range being set at 0.0–1.0%.

The inflation forecast published at the time of the assessment was based on a three-month Libor of 0.5%. It showed an inflation rate of less than 2% from the fourth quarter of 2008. The forecast inflation continued to drop back until the end of 2010, apart from a brief climb in the fourth quarter of 2009 due to a base effect triggered by oil price movements. The forecast showed an inflation rate of 0.9% in 2009 and 0.5% in 2010. The slight increase in inflation expected at the end of the forecast period can be explained by the fact that a Libor of 0.5% does not represent an equilibrium level which guarantees price stability in the medium and long term.

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