More Swiss Franc weakness to come

The Swiss central bank (SNB) is not in a hurry

In 2017, the Swiss economy grew by 1,1% on the back of stronger domestic consumption and investments as well as strong exports demand as a result of the global demand recovery. In 2018, economic growth is expected at 2% by the central bank with exports accelerating thanks to the improved external environment and domestic consumption providing an additional stimulus. Nonetheless and darkening the overall picture is inflation. While currently at a 7-year high, inflation is only slowly ticking up and stands only at 0,8%, far from the 2% target fixed by the Swiss National Bank (central bank). The central bank indeed downgraded at its last meeting its inflation forecasts to just 0,6% in 2018, 0,9% in 2019 and 1,9% in 2020. Given the inflation outlook, the central bank is unlikely to tighten its monetary policy soon (balance sheet reductions and interest rate increases). While the market expects the central bank to deliver one 25 basis points rate hike in 2019, we think this is only likely if the CHF continues to depreciate versus euro and if the European Central Bank clearly engages into a tightening cycle. We think that the yield differential will be key. Moreover, the SNB has been considering the Swiss franc as “highly valued” in the past couple of years and continued to do so at its last meeting. Removing some monetary accommodation would be counterproductive in that sense as it would likely lead to the Swiss franc appreciating
 

More weakness for the Swiss franc (against euro)

The Swiss franc depreciation over the 12 last months has come in line with the relief in terms of most Eurozone political  risks (following German, Italian and French elections), as fears over a “hard Brexit” have decreased and as trade tensions should not turn into a trade war.  The reduction in uncertainty led to large outflows from Swiss assets. Low Swiss bond yields probably reinforced the move. Looking forward, our base case scenario assumes a rising global risk appetite, which does not suggest that safe haven currencies will perform well. Second, as we expect inflation to remain low, the Swiss National Bank should remain cautious for a long time and even more than the ECB. Higher yields abroad should continue to lead to outflows from Swiss assets. We could see a temporary pause of the recent depreciation trend as the technical indicators suggests that the euro is overbought against the franc. We update our targets to 1,19 in 3 months and  1,22 in 12 months (value of 1 EUR). This suggests more weakness compared to our previous scenario.
 

Long-term fair-value

Economist often use the purchasing power parity (PPP) as a forecasting tool for the long-term fair-value of a currency. This is based on the assumption that the value of a basket of goods should converge when it is measured in the same currency. Based on calculation made by the OECD, the Swiss franc fair value stands at 1,55 (value of 1 EUR). Many studies however suggest that a full convergence is unrealistic and use half-life approach – i.e. using an adjustment of half of the deviation from fair value.  Such an approach would suggest a medium-term level around 1,35 (value of 1 EUR) which is more realistic to us. Supporting this measure is BNP Paribas own fair-value indicator, based on several fundamentals factors, which also point to a fair-value of 1,35.