Why prices are stable in Switzerland

In the industrialized world's worst cost-of-living crisis in a generation, Switzerland appears to be something of an island of the blessed. Year-on-year price increases of currently just over 3 percent are the lowest in the OECD and a fraction of what is seen in the euro area and the United States. Nevertheless, the Swiss National Bank (SNB) is warning that it may have to raise interest rates further.

How the small Alpine country resists the inflation trend could be instructive for others as well. The national currency has helped, as have policies that have shielded the Swiss from the problems of their neighbors while still maintaining an open economy.

Seven reasons

Monday's latest consumer price index shows prices rising 3.3 percent. There are seven reasons why inflation in Switzerland is so low compared to other countries.

1. Strong franc

In a recent interview, SNB President Thomas Jordan called the franc "probably the most important" reason for lower price growth. He said the currency's appreciation had "absorbed some of the inflationary pressure from abroad."

Since its low point in 2021, the franc has appreciated by around 13 percent in nominal terms against the euro, making imports cheaper and creating a kind of inflation protection wall for Switzerland against the outside world.However, the dampening effect of the franc is commonly overestimated, says economist Maxime Botteron of Credit Suisse in Zurich. According to his calculations, a 10 percent appreciation of the Swiss franc against the euro leads to a decline in overall inflation of only 0.5 percentage points.

2. Inflation basket

Jordan also pointed to the lower weight of energy in the price basket used to measure inflation in Switzerland. While electricity and fuels account for 6.6 percent of the harmonized European consumer price index, in Switzerland it is only 3.4 percent. The federal data presented Monday was based on a new basket of goods in which energy prices have an even lower weight than before.

Because of the smaller share of total spending, higher energy prices have not fueled inflation as much in Switzerland. Simple math aside, the Swiss economy can claim to be more energy efficient than its European competitors. "A shock in energy prices does not lead as quickly to a rise in consumer prices, which limits second-round effects," says Alessandro Bee, an economist at UBS.

3. Lower starting point

Switzerland has had limited recent experience with price increases, but was already one of the most expensive countries in the world for consumers. The SNB also has a lower inflation target than its counterparts. It aims for an inflation rate between 0 and 2 percent. In 2020, the price level even shrank by 1.3 percent at times. Over the past decade, the Swiss economy has recorded disinflation in almost half of all monthly data.

Swiss consumers' expectations for inflation are muted, which UBS economist Bee calls an "inertia effect." "People have become accustomed to low inflation for decades, so inflation expectations are somewhat rigid," he elaborates.

4. Food prices

Food inflation in Switzerland is considerably lower than elsewhere in Europe. A 4 percent price increase in the Swiss Confederation compares with 16 percent inflation in the euro area. Credit Suisse economist Botteron sees "Swiss protectionism" as the main reason for this. Pressure on food prices should also result from the fact that many Swiss are switching to neighboring countries to do their shopping. This should have limited the ability of Swiss retailers to raise prices.

5. Regulated prices

The share of government-controlled prices is higher in Switzerland than in other economies. Household electricity bills can only be changed once a year. This fact in particular explains the 0.5 percentage point increase in inflation last month. "As a rule, this only means a delay in price increases," says UBS economist Bee. Also working against consumer price inflation, he says, was the fact that wholesale electricity prices had already eased somewhat by the time price increases became possible in January.

6. Drug comparisons

According to Credit Suisse's Botteron, an inflation reduction of about 0.1 percentage points resulted from the fact that Swiss authorities can compare drug costs in the country with levels in other countries and prescribe price cuts. This is expected to have saved 250 million francs between 2020 and 2022, according to official figures.

7. No quantitative easing

Until the end of July last year, Switzerland had the most pronounced negative interest rates in the world, at minus 0.75 percent. Meanwhile, the SNB's decision not to engage in quantitative easing (QE) may have proved beneficial. The increase in money circulating in the economy as a result of bond purchases increases the risk of inflation, as economist Alexandra Janssen notes.

The managing director of Zurich-based consultancy Ecofin Portfolio Solutions points out that central banks that have bought massive amounts of their own countries' government bonds have seen a significant increase in M3 money supply. This measure also includes less liquid assets of financial institutions and companies."Switzerland has produced less inflation because the SNB has pursued a better monetary policy in this regard," Janssen said. Her point may be controversial among economists, whose arguments for QE are likely to generate debate in major economies for years to come.

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