Dovish SNB pushes EUR/CHF higher

On 14 September, the Swiss National Bank decided to lift its target rate by 25 basis points to 1.75%, meeting the market’s expectations. Surprising to both UBS and the market was the accompanying dovish press statement, where the SNB communicated that its “forecast shows that there is no immediate inflation risk”. This comes despite the SNB’s expectation of GDP growth of about 3% in 2006, still above-trend growth in 2007 and “a high level of capacity utilization”.

The SNB expects special factors to ease pressure on prices. The lack of any statement regarding CHF weakness against EUR added to the dovish taste of the statement.

Regarding growth, the situation in the eurozone is comparable to that in Switzerland. GDP has reached its cyclical peak and is expected to slow down going forward. It is inflation that makes the difference. The eurozone is facing stubbornly high inflation rates above its 2% target. This has led the ECB to adopt quite a hawkish stance.

The diverging trend in inflation and consequently central bank outlook between the eurozone and Switzerland has pushed interest rate expectations in favour of EUR and sent EUR/CHF higher. Immediately following the dovish SNB press release, EUR/CHF broke through technical resistance at 1.586, confirming the upward momentum in EUR/CHF. In light of this confirmation and UBS’s expectation of weaker interest rate support for CHF over the next months, UBS have raised their forecasts.

UBS now expect EUR/CHF to reach 1.60 in the next three months. Over the medium term, however,

UBS do not expect the CHF weakness to continue.

The CHF-negative impulses from rising interest rate spreads should peak in the first quarter of 2007. With these impulses running out of steam, we believe the market will refocus on better CHF fundamentals (e.g. valuation, current account and fiscal surplus) which should help the Swiss franc, especially over the 12-month horizon. While the 6-month forecast was changed to 1.58, UBS are sticking to their positive long-term view with a 12-month forecast for EURCHF of 1.53.