Why a strong currency is causing problems for Switzerland

U.S. President Donald Trump’s trade policies have rocked global equities in recent weeks, driving investors to seek out pockets of safety in financial markets.

One of the beneficiaries of the market volatility has been the Swiss franc, widely seen as a safe haven asset in times of macroeconomic or geopolitical uncertainty. The Swiss currency has appreciated 10% against the U.S. dollar since the beginning of the year – but inside Switzerland’s borders, rising demand for the franc is stirring up challenges for policymakers.

The Swiss franc was last seen trading 0.2% higher against the greenback, with $1 buying around 0.82 Swiss francs. Switzerland’s currency, which was trading flat earlier on Wednesday, rallied after ADP data showed hiring slowed to a two-year low in America’s private sector last month.

A strong franc puts deflationary pressure on Switzerland. As the currency appreciates, imports – which play a significant role in the country’s economy – become cheaper.

For some countries, this effect might be a welcome reprieve from sticky inflation. But while many developed markets, such as the U.S. and the U.K., are still working to bring inflation down to their 2% targets, Switzerland is facing the opposite problem: prices are falling too much.

Swiss inflation turned negative in May, with the country’s Consumer Price Index falling by 0.1% year-on-year. The price of imported goods contracted significantly, falling by 2.4% on an annual basis after staying flat in the previous month.

Charlotte de Montpellier, senior France and Switzerland economist at ING, noted the role the currency rally was playing in the country’s inflation picture.

“The latest decline is largely driven by external factors,” she said in a note on Tuesday. “A strong Swiss franc has significantly reduced the cost of imported goods … Given that imports make up 23% of the CPI basket, this has a notable impact on overall inflation in Switzerland.”

The May data marked Switzerland’s first return to deflation since the Covid-19 pandemic. It could push the Swiss National Bank toward utilizing two key policies previously implemented to address what De Montpellier labeled a “persistent headache” for the central bank.

The SNB ended a seven-year stretch of negative interest rates in 2022 — an unpopular policy with savers and lenders, as they eliminate returns on savings deposits and squeeze banks’ margins and profitability.

At its most recent meeting in March, the central bank cut its key rate by 25 basis points to 0.25%.

In the wake of this week’s inflation data, the SNB is expected to “seek to combat the appreciation of the Swiss franc with the weapons at its disposal,” De Montpellier said.

ING expects the SNB to cut its key interest rate by 25 basis points at its next meeting later this month — and De Montpellier argued that further cuts will likely follow.

“Based on current data, a return to negative interest rates before year-end appears increasingly probable,” she said. “Our base case includes a second 25bp cut in September, bringing the policy rate to -0.25%. While the SNB would prefer to avoid deeper cuts, a 50bp reduction in June cannot be ruled out.”

While ING expects Swiss policymakers to stop cutting rates at -0.25%, De Montpellier said a further strengthening of the Swiss franc “could force [the SNB’s] hand,” leaving it with little choice but to take rates further into negative territory.

Lily Fang, a professor of finance at business school INSEAD, told CNBC that current conditions were likely to push Switzerland back into a negative rates environment — a move that SNB Chair Martin Schlegel has stressed remains on the table.

“The Swiss authorities are clearly concerned, because … it’s a small, open economy that relies on international trade, and the U.S. in particular is their single most important trading partner beyond the EU bloc,” Fang said in a phone call.

“Switzerland has already gone ahead and lowered rates ahead of the EU. I think it is very likely to go to zero and even negative.”

Back in 2020, the U.S. Treasury, under the first Trump administration, labeled Switzerland a currency manipulator, accusing it of deliberately devaluing the Swiss franc against the greenback. The SNB denied those allegations at the time.

Trump’s full list of so-called reciprocal tariffs said “currency manipulation and trade barriers” had been factored into calculating the levies individual countries were imposing on the United States. The administration said it had calculated that Switzerland — which abolished all industrial tariffs last year — charged tariffs of 61% to the U.S., and it would therefore slap new tariffs of 31% onto Swiss goods.

While ING’s De Montpellier acknowledged that any possible FX intervention from the SNB risked “provoking the ire of the US administration,” she argued it was likely the central bank would intervene in markets in the coming months.

Alex King, a former FX trader and founder of personal finance platform Generation Money, agreed that any direct purchase of foreign currencies by the SNB was “unlikely to sit well with the US administration.”

“When Switzerland was labelled a currency manipulator in 2020 the threat of tariffs wasn’t such a major factor, but it now has a dilemma on its hands,” he told CNBC in an email. “If it was to intervene directly again in FX markets, it could get hit with higher US tariffs, and the negative impact of this could be worse than short term inflationary pressures.”

Last month, SNB’s Schlegel said Swiss officials had held constructive talks with the U.S. on the central bank’s FX interventions, in comments cited by Bloomberg.

“We have never influenced the exchange rate to get us an advantage,” he reportedly told an audience in the Swiss city of Lucerne.

“I’m not sure that they will immediately go and use currency intervention, market intervention, because the U.S. tends to be … labeling countries ‘manipulators,'” added INSEAD’s Fang. “I don’t think that they really want to be labeled as a manipulator again, [so] I think that they will use that probably as a last resort tool.”