Switzerland is now flirting with deflation, causing a dilemma for its central bank

Switzerland could be at risk of slipping into deflationary territory next year, as a stronger Swiss franc beleaguers policymakers’ efforts to get a handle on price growth.

The Swiss National Bank cut interest rates for the third time this year in September, citing the strength of the safe-haven currency as a key driver of the country’s falling inflation rate, alongside lower oil and electricity prices.

The central bank also revised down its forecasts, putting the average annual inflation rate for 2024 at 1.2% from 1.3%, while projecting price increases will grow by 0.6% in 2025, compared with a previous outlook of 1.1%.

Outgoing SNB chairman Thomas Jordan said at the time that the strong franc had had a “material impact” on the revisions, but downplayed the risk of deflation, noting that the forecasts remained “within the range of price stability.” He added that policymakers remain poised to adjust monetary policy further to get a handle on inflation.

But analysts say it now looks increasingly likely that the bank will have to lean on foreign currency intervention to prevent the country from slipping into a deflationary environment.

“There is some scope for further interest rate cuts but, given the scope for franc appreciation to push Switzerland into deflation territory, it would make sense for the SNB to directly target the currency’s valuation through FX interventions,” Adrian Prettejohn, Europe economist at Capital Economics, told CNBC by email on Monday.

Foreign exchange (FX) interventions take place when a bank buys or sells its currency in the FX market to raise or lower its value against another currency. Such measures can reduce price distortions, which can impact inflation, particularly in trade-heavy economies.

“We would not rule out the possibility of interventions in the FX markets in periods of sharp appreciation pressure,” Sophie Altermatt, Julius Baer economist, told CNBC by email.

The Swiss franc has rallied over recent months and is currently hovering near record highs, as investors have piled into the safe-haven asset amid market volatility and the unwinding of the yen carry trade.

As of Wednesday, EUR/CHF was seen trading around 0.9414 and USD/CHF at 0.8669.

Swiss inflation has meanwhile continued to fall.

Switzerland was an outlier among major economies in the double-digit inflation spiral of recent years, with prices rises in the small European nation topping out at a 29-year-high of 3.5% in August 2022. In March, with inflation at 1.2%, the SNB become the first major Western central bank to cut interest rates.

Inflation declined further in September, recording an annual rise of 0.8%, compared to 1.1% in August.

Capital Economics said in a note last week that it now sees inflation in Switzerland falling to 0.3% in 2025, down from its previous estimate of 0.8%, due to the strength of the franc and lower oil and housing costs. That figure could turn negative in certain months, Prettejohn noted Monday.

“Our forecast is for inflation to fall as low as 0.1% in some months, so it would not take much to push that below zero,” he said, describing deflation as a “real possibility.”