Swiss Slope Towards Zero Rates

The country's central bank cuts rates to 0.5% as inflation eases, saying it could do more if necessary.

Switzerland may have one of the world's best standards of living and may be a magnet for private-banking clients, but the country's economy has not escaped the global financial crisis. The Swiss National Bank (SNB) cut interest rates by 0.5% on Thursday, bringing its already-low benchmark rate of lending down to 0.5%, and putting it on track to potentially be the first country in Europe with a zero-interest rate policy.

The central bank said Switzerland's economy would contract by 0.5% in 2009. It also dropped its inflationary outlook for next year to 0.9%, from 1.9%, and its 2010 inflation outlook to 0.5%, from 1.3%, largely because of the sharp fall in oil prices. The rate cut was the SNB's fourth in two months.

TheSNB said the global economic environment had sharply deteriorated over the last few months and that international financial markets had "worsened further" since September. "The Swiss economy will be heavily affected by these developments," it said, adding that it would continue to "implement further measures should the situation require so."
As interest rates fall lower across the world--they are now 0.3% in Japan and 1.0% in the United States--central banks are seeking out unconventional measures to help ease monetary conditions. The United States, for instance, is buying mortgage-backed securities that were issued by Fannie Mae and Freddie Mac, a form of so-called quantitative easing.

Unicredit analyst Alexander Koch predicted the SNB would, similarly, purchase corporate and government bonds as a way to help keep the rate of interbank lending in Swiss francs closer to its new target rate of 0.1-1.0%. "That's the remaining maneuver for them because short term-rates are close to zero," he said, adding that it would only go that low "if things get really bad."

The Swiss franc has meanwhile fallen against the euro since hitting a record high in October; the SNB has cut rates more aggressively than the European Central Bank in recent months to help steady the currency and thus Switzerland's export-driven economy. Some 75.0% of Swiss exports go the European Union.

Koch expects the Swiss franc to devalue somewhat in the short term, but then to firm up again afterwards, since a generally decreasing appetite for risk should keep forex investors heading back towards the currency as a safe haven.

The Swiss franc fell against the euro on Thursday after the rates decision. The euro bought 1.5640 Swiss francs, up from 1.5609 francs on Wednesday in New York. It was up against the dollar though, with the greenback buying 1.5483 francs, down from 1.5559 francs. The CurrencyShares Swiss Franc Trust (nyse: FXB - news - people ), an exchange-traded fund that tracks the Swiss currency, closed up 0.7%, or 59 cents, at $83.50 in New York on Wednesday. It has fallen by a respectable 5.5%, or $4.88 since the start of the year.