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When is it time for the SNB to think about the exit?

According to Goldman Sachs, the SNB’s exchange rate ceiling against the Euro is often seen as a binding constraint on its future interest rate decisions. But the exchange rate commitment is only likely to become a constraint on rate decisions if the CHF remains close to the 1.20 level against the Euro....

SNB in no hurry to hike …

Euro area weakness is set to adversely affect the Swiss economy, which we expect to stagnate in the second half of this year. Even though we expect Swiss growth to regain momentum next year, this growth pause implies a delay in the build-up of domestic inflationary pressures that we eventually expect to materialise. Consequently, we have pushed back our forecast for the first SNB rate hike to June 2016 (from December 2015 previously). Market pricing, however, suggests a still later date for rate hikes, with forwards showing a rise in the 3-month CHF Libor only in late 2016.

… but market too dovish

We see market pricing as too dovish. Notwithstanding its current weakness, the Swiss economy has been growing steadily over recent years. Disinflationary pressure from the sharp appreciation of the Swiss Franc (CHF) exchange rate at the peak of the Euro area crisis in 2011 is now abating. Credit growth remains buoyant. Indeed, the SNB is worried about rising imbalances in the housing sector. Although macro-prudential tools have been employed to counter such imbalances, in our view the SNB is unlikely to see these measures as a permanent and complete substitute for traditional policy instruments.

CHF ceiling eventually not a binding constraint to rate hikes

The SNB’s exchange rate ceiling against the Euro is often seen as a binding constraint on its future interest rate decisions. But the exchange rate commitment is only likely to become a constraint on rate decisions if the CHF remains close to the 1.20 level against the Euro. There are several reasons that would argue for a depreciation of the CHF against the Euro, opening up the possibility for the SNB to eventually start tightening policy. Most importantly, we expect the situation in the Euro area to gradually improve again over the course of the next year, thereby reducing the risk of a re-emergence of safe haven inflows into the CHF. Moreover, models explaining the CHF using interest rate differentials and measures of overall market uncertainty already currently point to a weaker CHF. And the decline in long-dated volatility makes the CHF attractive again as a funding currency for carry trades.

Goldman Sachs , October 2014

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