The SNB implements its monetary policy by setting the SNB policy rate. In so doing, it seeks to keep the secured short-term Swiss franc money market rates close to the SNB policy rate. The most representative of these money market rates today is SARON.
In addition to steering interest rates via its policy rate, the SNB also has other ways of implementing monetary policy. In particular, it can intervene in the foreign exchange market as necessary, buying or selling Swiss francs against foreign currencies.
Repo transactions are one of the key instruments that the SNB uses to implement monetary policy. In a repo transaction, the cash provider buys securities from the cash taker. The countervalue is credited to the cash taker’s sight deposit account. Simultaneously, the parties enter into an agreement whereby the cash taker buys back the securities at a later date. The cash taker thus receives a short-term Swiss franc loan from the cash provider for the term of the transaction on which it pays interest at the repo rate. The cash provider receives collateral in the form of securities. The SNB may operate on the repo market both as cash taker and cash provider. In addition to repo transactions, the SNB also has other instruments for implementing monetary policy.
The SNB defines how much money it wishes to make available to the banks, at what price (repo rate) and for how long, thereby influencing interest rates within the economy. The size of these repo transactions determines how much money (or ‘liquidity’) the banks receive from the SNB.
When the SNB changes its policy rate, SARON adjusts in line with the change. Why? Only the SNB is able to steer Swiss franc liquidity, and therefore it alone can define the price (i.e. interest) charged for this liquidity. The interest rate terms for monetary policy instruments are based on the SNB policy rate. The interest on sight deposits currently corresponds to the SNB policy rate, for example. In this way the SNB makes sure, when implementing its monetary policy, that the secured short-term money market rates are close to the SNB policy rate.
However, the effect of the SNB policy rate described above is not limited to SARON, as the banks also adjust the interest they charge on loans to companies and private individuals (e.g. mortgages).
Let us assume the SNB’s inflation forecast points to a sharp rise in inflation. What action should be taken? In order to counteract the threat of inflation, the SNB tightens its monetary policy. It announces that it is raising the SNB policy rate. The banks consequently raise their own lending rates. Companies and households, in turn, take out fewer (now more expensive) loans, which reins in demand for goods and services. Companies cut back production. As they are no longer able to sell their products as well as previously, firms refrain from further price increases.
Any such tightening also engenders effects via the exchange rate: when interest rates are higher, the Swiss franc appreciates. Imports become cheaper, which has a direct dampening effect on inflation. Exports, on the other hand, become more expensive and foreign demand for Swiss goods declines; this indirectly dampens inflation. The SNB thus achieves its objective in that the risk of inflation is warded off.
Repo transactions can be used not just to increase, but also to decrease liquidity at banks. Liquidity-absorbing repos work like liquidity-providing repos, just in reverse. The SNB sells securities to a bank at a defined price and the parties simultaneously agree that the SNB will buy back the securities at the end of the contract term – at a higher price. The difference between the repurchase price and the sale price is the interest (or repo) rate that the SNB pays the commercial bank.
The monetary base M0 is composed of banknotes in circulation and domestic banks’ sight deposits with the SNB. M1 includes money that can readily be used to make payments at any time: cash in circulation and Swiss franc-denominated sight deposits at commercial banks. M2 is comprised of M1 plus Swiss franc-denominated savings deposits. M3 is made up of the M2 monetary aggregate plus Swiss franc-denominated time deposits. The monetary base is the only monetary aggregate the SNB can steer directly; it influences the others indirectly through its monetary policy.
It began in August 2007 when the real estate bubble in the US burst. With the collapse of the US investment bank Lehman Brothers in September 2008, a financial crisis the like of which the world had never seen was unleashed.
The SNB, along with other central banks, reacted quickly and comprehensively. It lowered the target range for the reference interest rate in several increments and provided the banking system with ample liquidity. At the same time, the SNB collaborated with the Confederation in putting together a package of measures to support the beleaguered UBS. It created the so-called StabFund and granted this entity a loan. The StabFund then took over UBS assets that the market had suddenly turned its back on. These measures allowed UBS to stabilise its finances and buttressed the Swiss finance industry as a whole. In 2013 the SNB successfully closed the StabFund chapter.
The financial crisis led first to a severe downturn in the global economy, then, in 2010, to the debt crisis in the euro area. The SNB reacted with a range of exceptional measures aimed in particular at the strength of the Swiss franc, which had appreciated substantially as a result of the euro crisis, thereby bringing deflationary risks with it. It lowered the target range to zero, flooded the banking system with liquidity and purchased foreign currencies against Swiss francs. On 6 September 2011, the SNB set a minimum exchange rate of CHF 1.20 per euro. Until 15 January 2015, the minimum exchange rate stood at the centre of monetary policy and the SNB enforced it with the utmost determination.
The monetary base increased more than tenfold between 2007 and 2018. Despite this, the SNB’s inflation forecast indicates that there are no inflation risks for Switzerland in the foreseeable future.
On 18 December 2014, the SNB announced it was introducing negative interest rates. This move was designed to make Swiss-franc investments less attractive and thereby support the minimum exchange rate. On 15 January 2015, the SNB discontinued the minimum exchange rate. In order to counter undue tightening of monetary policy, the SNB simultaneously took interest rates even deeper into negative territory and announced its intention to remain active in the foreign exchange market, as necessary.
The interest rate on sight deposits with the SNB has since remained at –0.75% and is thus the same as the SNB policy rate. The introduction of negative interest rates had fundamentally the same effect as an interest rate cut in positive territory. Interest rates in Switzerland generally declined across the board.
Thanks to negative interest rates, the SNB has managed to ensure that Switzerland’s interest rate level is once again below that of other countries. If, for example, interest rates in the euro area fall, but the Swiss franc interest rate stays at zero, the interest rate differential between the Swiss franc and the (typically higher-interest) euro diminishes. This makes Swiss franc investments more attractive than investments in euros. Demand for Swiss francs thus increases and the currency strengthens.
Negative interest helps to once more widen the interest rate differential with other currencies. When investments in Swiss francs earn less interest than in other currencies, they are less attractive. The negative interest rate thus helps to ease demand for the Swiss franc, and should contribute to a weakening of the currency.
The increase in the monetary base also has implications for the SNB’s balance sheet. The balance sheet total was approximately CHF 100 billion before the crisis; at the end of 2016, it stood at CHF 747 billion. This state of affairs presents risks for the SNB’s annual financial statements because, as recent years have clearly shown, the result may fluctuate substantially due to exchange rate movements. But the SNB’s balance sheet is ultimately dictated by monetary policy. The fact that it has expanded to its current size is a consequence of monetary policy measures that are necessary in order to ensure price stability.