Switzerland: Can it surmount the strong franc?

Market analysis - 6/6/2016

Growth is on the verge of accelerating as manufacturing sentiment picks up. Lower housing prices could tamp down on consumer spending

Switzerland has delivered positive growth despite the obstacle posed by the strong franc. Gross domestic product (GDP) rose by 0.1% in the first quarter of 2016. That equates to a +0.7% year-on-year rise, in line with our estimates. Economic activity was fuelled by consumer spending and by corporate spending on both construction and capital goods. The trade balance and public spending, however, weighed on growth.


The Swiss economy fared less well than the Euro Zone, which turned in full-year growth of +1.5%. But the future is bright: growth is on the verge of accelerating as manufacturing sentiment picks up. The PMI and the KOF economic barometer are sharply up, pointing to an economic improvement in the coming months. The PMI has climbed 5.8 points in four months to reach its highest level since February 2014.

With consumer confidence rising, the employment outlook stable and the franc weakening slightly, all systems are go. We expect the Swiss economy to grow by +1.1% in 2016. Estimates from the main economic institutes range from +0.8% to +1.4%.

That said, it will take time for the recovery to take root. We expect growth of only +1.2% in 2017 versus the consensus estimate of +1.6%. Like the Gotthard tunnel, the Swiss economy will have to get past the obstacle posed by the strong Swiss franc before growth will top 2%. This will require some serious effort. The currency will have to weaken further or companies will have to improve productivity levels.

While consumer prices have declined by a cumulative 3.1% over the past five years, producer prices have dropped by 6.9% over the same period. This suggests that downward pressure on prices is not the result of a demand shock, as is the case in true deflationary phases. The fact that companies still wield some pricing power shows that the drop in producer prices stems from a supply shock following the franc's sharp rise and the downward trend in commodity prices.

Property prices are of particular interest nowadays. After rising since 2000 at an average pace of 2.9% per year, they recently headed south. The Swiss housing market was overheated for several years (see right-hand chart) thanks to high levels of household wealth and historically low mortgage interest rates.

The Swiss National Bank, with the help of the Swiss government, has sought to address this situation in the past few years. It has, for example, adjusted the required down payment, accelerated amortisation schedules, and increased the counter-cyclical capital buffer applied to lending banks. Housing prices have now stopped rising.

This will go a long way towards avoiding a bubble and achieving long-term economic growth. What is not clear is the extent to which consumer spending in Switzerland will decline as a result.

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