A country where the interest rate can be negative again

One of the most extreme phenomena of the global economy and central bank monetary policies was the application of negative interest rates roughly between 2015 and 2021, and this had a predictable result: inflation exploding in 2022. After that, it became obvious that this experiment failed, so most central banks will not play with this idea again.

Japan abandoned it, Switzerland is starting again

Even Japan abandoned the practice after realizing that negative interest rates alone and the fact that the central bank bought up more than half of the national debt would not lead to economic growth in the country that had taken over the role of the world’s factory from lower-wage Asian countries, but the yen is rapidly depreciating. They were forced to raise the central bank’s base interest rate to the positive range, they began to return the government securities purchased by the central bank to the market, so the yield on the 10-year Japanese government bond rose above 1 percent.

At the same time, there is a special country where the extraordinary development of circumstances may once again justify the application of negative interest rates. Switzerland’s new central bank president, Martin Schlegel, announced on Friday that they will not shy away from this, given that the Swiss franc is so strong that it is holding back the economy, but at the same time, the inflation target is treated much more loosely than other central banks: the target value is not 2 percent, but 0 and anything between 2 percent is fine.

Small currency, many buyers

The excessive strength of the Swiss franc is not justified by fundamental factors: the country does not have a gigantic export surplus, which leads to an appreciation of the currency. The problem is that, for historical reasons, half the world, or at least half of Europe, sees the franc as a kind of escape tool that can survive any economic crisis or even war, and therefore many people keep their money in francs even if there is no interest. They can be dissuaded by the fact that a significant negative interest rate consumes their savings year after year, so they are finally willing to give up the franc.

But why does it cause so much trouble that many people flee to the Franks? The answer is simple: Switzerland is a small country with 9 million inhabitants, and although it is one of the richest countries, the size of its economy and thus the amount of foreign currency required for its operation cannot be compared to that of the Eurozone, not to mention the economy of the whole of Europe. Thus, the excessive demand drives the franc up to an unrealistic level, and if the Swiss central bank buys a lot of foreign currency, as it did until 2015, it creates an unrealistically large foreign exchange reserve compared to its economy.

A forced move

The new central bank president said that they do not like negative interest rates, it is fundamentally against economic rationality, but they will be forced to use them if this is the only way to keep the exchange rate of the franc at a level that is still acceptable to Swiss exporters. If the exchange rate makes it impossible to export even with the most efficient production possible, the economy may decline, it would go into recession. A better solution would be a negative interest rate (of course, they could enter the euro zone and then the franc would cease to exist, but this has not been considered as a possibility so far).

They quickly put an end to inflation

The previous negative interest rate was abolished by the Swiss National Bank in September 2022, mostly in the context of action against inflation, but inflation in the Alpine country quickly subsided, so interest rate cuts have already followed this year, and the base interest rate is currently 1 percent. Reuters at the December interest rate meeting according to 72 percent of market participants expect a cut of 25 basis points, and 28 percent expect a reduction of 50 basis points.

What indicates the expected appearance of negative interest rates is the yield on the 10-year Swiss government bond: after a sharp decline, it stands at only 0.2 percent, i.e. it is not far from taking on a negative value. Meanwhile, the similar yields of the member states of the euro zone range between 2 and 3.3 percent, so it is now believed that their surplus compared to the Swiss yield will remain permanent, reducing the demand for the franc.