SNB to Resume Intervention Soon

Swiss franc surged against the euro and the dollar by -7.22% and -6.37% respectively in June with the rallies accelerated after SNB's meeting on June 17. The central bank raised its inflation forecasts and stated that the deflationary risk in Switzerland has largely disappeared. At the same time, the SNB did not reiterate the stance to 'act decisively to prevent an excessive appreciation of the Swiss franc against the euro' although the franc has strengthened +8% against the euro over the past 6 months. This indicated the SNB's increased tolerance to the decline of EURCHF.

However, weaker-than-expected CPI data for June and rise in MCI signaling slightly more restrictive monetary condition in mid-June made us worry that deflation may not have disappeared and Swiss franc may have risen excessively. We believe the SNB will also monitor closely these parameters and resume intervention of the currency.

Forecasts of USDCHF

Economic recovery in Switzerland has been resilient. Real GDP grew +0.4% in 1Q10 after expanding +0.9% and +0.5% in 4Q09 and 3Q09 respectively. The KOF leading indicator of business expectations improved to 2.25 in June from 2.16 in the prior month while PMI slid to 65.66 from 66.45 but remained at elevated levels.

Despite these, CPI eased further to +0.5% y/y in June +1.4% in April and fell -0.4% m/m on monthly basis. Excluding food, energy and seasonal items, core inflation remained at around +0.2% y/y but contracted -0.4% from a month ago. Concerning the job market, unemployment rate slid to 3.9% in June from 4% a month ago. While we believe unemployment rate probably peaked in December 2009/January 2010, the pace of decline has been slow and current level has remained well-above pre-crisis level of 2.5%.

According to SNB's Quarterly Bulletin for 2H10, The Monetary Conditions Index (MCI) rose sharply in June. Rise in MCI indicates monetary conditions have tightened and the surge in June was mainly a result of appreciation of CHF against EUR.

As Switzerland's inflation outlook remains weak (despite SNB's upgrades) and monetary conditions have shown signs of tightening as driven by strength in Swiss franc, economic growth may surprise to the downside later this year. The SNB should act against CHF appreciation before it's too late.

While the SNB mentioned in June's meeting statement that the current expansionary monetary policy 'cannot be maintained over the entire forecast horizon without compromising medium and long-term price stability', we expect the central bank to leave the 3-month Libor target at 0.25% for the rest of the year.

Monetary Policy Forecasts