Swiss: Preview of the SNB Meeting on December 11

Overview: The SNB has cut its target rate by a whopping 175bp in just two months, making monetary policy rather expansive with a target rate of just 1%. However, the outlook for the real economy has deteriorated significantly, and given that the SNB has reached its inflation target we see scope for a further easing of monetary policy. We are looking for the SNB to ease monetary policy even though the spread between 3M LIBOR and the target rate is not eliminated completely. We believe a cut of 50 basis points is the most likely outcome, which is also the consensus among analysts - although the futures market is pricing in just a 25bp cut. We thus expect the 3M LIBOR target band to be lowered to 0.0-1.0%.

That said the uncertainty surrounding the quarterly meeting is greater than normal. The SNB may consider the current 15bp spread between 3M LIBOR and the target rate as too high to allow a cut in the target rate and we believe it will be a close call. In a way it would not be credible to cut target rates before the current target of 1.0% is met. The two rate cuts in November both came after the target rate had been reached, while the SNB elected to participate in October's coordinated rate cut despite 3M LIBOR fixing more than 25bp above the target at the time.

Global economic outlook: The SNB is expected to have revised the September projections in two areas. First, it now assumes a weaker economy for the remainder of 2008 and in 2009, in the US and in Europe. Second, the SNB now predicts a more marked drop in inflation in the US and Europe next year than it did three months ago. These revisions should be seen in connection to the marked deterioration of key figures for both the Europe and the US in recent months. Business sentiment has dropped markedly. The US ISM has declined sharply to 36.2 and Euroland manufacturing PMI had dived to 35.8; a new record low level. German industrial orders decline more than 6% m/m in October corresponding to a 17% decline y/y. Recession dynamics have materialised most clearly in the US where employment declined by more than 500,000 individuals in November. In Euroland unemployment has been rising in recent months. Over the coming months more weak economic indicators are likely to come out of both the US and Euroland.

Swiss economic outlook: The international economy has a strong impact on the Swiss economic outlook. Consequently, developments in the Swiss economy depend heavily the path of the global economy. The overall economy had, however, not yet fallen into contraction. According to the recently published national accounts, the Swiss economy merely stagnated in Q3. Once again it was net exports that kept growth above water, while a sharp fall in inventories pulled in the other direction. Looking at the individual sectors, the financial crisis is still being keenly felt in the financial sector, which for the third quarter in a row shaved more than half the growth off the Swiss economy. Unemployment remains at a low level.

The PMI index for November fell to just 35.2 and we expect that Q4 and the first quarters of 2009 will show an actual fall in overall activity. SNB members have mentioned that they expect the economy to contract in 2009.

Monetary and financial conditions: The Swiss franc has appreciated against the euro in recent months on the back of continued turbulence in the financial markets and the further carry financial deleveraging. However, during past weeks EUR/CHF has moved higher, now trading more than 12 big figures above the October 1.43 low.

Since the last intermeeting rate cut SNB chairman Roth has sounded dovish mentioning, that "monetary policy is to remain expansive in the coming months" and that "the SNB has clearly indicated that monetary policy has to be decisively expansive".

Assessment and outlook: Given that the SNB delivers 50bp, as we expect, the Swiss franc is likely to see some pressure, as the market is only pricing an expected 25bp rate cut. We would thus expect to see EUR/CHF move marginally higher on the announcement. Following the last 100bp intermeeting rate cut on 20 November interest rates came down significantly and the swap-curve steepened. A 25bp cut would likely be more market neutral, while we could see some support to CHF if the SNB stays on hold.

If the SNB cut the target rate by less than a 50bp cut we expect it would deliver an intermeeting rate cut prior to the scheduled March meeting, which would also likely be priced in the market - implying that 3M LIBOR futures will continue to be priced below the current fixing.

Inflation and inflation risks: The outlook for inflation has improved in recent months due to the fall in oil prices in recent months and the forecast slowdown in economic activity. The fall in oil prices since July has, in combination with the stagnating activity, triggered a large drop in inflation from 2.6% in October to just 1.5% in November. Thus the Swiss National Bank (SNB) has already reached its inflation target. Over the coming months inflation is likely to decline further and it is likely to be negative for a short period during summer 2009 mainly due to base effects. During the second half of 2009 a pick up in inflation to a level consistent with price stability is on the cards.

Danske Bank
http://www.danskebank.com/danskeresearch

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