The end of negative interest rates

The time has finally come: the SNB, and thereby Switzerland, are leaving the negative interest rate regime. But what does that mean exactly?

The end of the negative interest rate era is here. On Thursday, 22 September, the Swiss National Bank (SNB) raised its key interest rate to + 0.5%. The SNB raised the interest rate for the first time in 15 years in June – to -0.25%. It has now gone one step further.

Here's what you need to know about this historic decision:

How high is the interest rate decision?
The SNB is further tightening its monetary policy and is raising the SNB's key interest rate by 0.75 percentage points to + 0.5%. The interest rate change will apply from Friday, 23 September. The CEO of the SNB, Thomas Jordan, has thus written a piece of Swiss economic history. With the interest rate hike of 0.75 percentage points, he has met the expectations of many experts. And many of them assume that this will not be the last interest rate hike.

"We expect key interest rates to rise to 1.25% by mid-2023," says UBS. After almost eight years, what has been described as a historical monetary policy experiment is over. People who lent money to the SNB received no interest, but had to pay interest.

From when did the negative interest rate regime apply? And why was it introduced? The negative interest rate regime was introduced in December 2014, and the SNB decided to abolish the minimum exchange rate in January 2015. The inflow of money from the euro area would have otherwise become too large, the SNB argued, and it would have had to buy up too many euros. The then SNB Deputy Director Fritz Zurbrügg told the media: "The minimum exchange rate could no longer have been maintained." In order to slow down a further rapid appreciation of the already overvalued Swiss franc against the euro and the dollar, the key interest rate was lowered to the unprecedented and world's lowest ever level of -0.75%.

Why is the interest rate reversal taking place right now?
Now that the Corona crisis has subsided, Western industrialised countries have seen a return to inflation. Inflation in Switzerland, was most recently at 3.5%, whereas there had previously been virtually no inflation for a decade. The US had an inflation rate of 8.3% in August, compared to the same month last year. Inflation in the eurozone has been measured at 9.1%. Above all, not only have the various energy sources – i.e. gasoline, heating oil, gas or electricity – became more expensive, but also food. The following message came from the statistics office of the European Union this week: "Bread is more expensive than ever" - it costs 18% more than a year ago.

Thomas Jordan, Chairman of the Governing Board of the Swiss National Bank SNB.          Photo: Anthony Anex

Central banks are now trying to combat this return to inflation by raising their key interest rates. In other words, they are putting the brakes on the economy with interest rate hikes, which, in turn, should have a dampening effect on the price levels.

What are the concrete consequences of the interest rate turnaround?
The higher key interest rates will be immediately passed on by the banks. Money (borrowing) will thereby becomes more expensive for everyone. Interest rates on mortgages are rising, as are the rates for consumer loans or business loans. Interest rates are also rising on the capital markets, and major companies and governments will have to pay more on their bonds. The chain of cause and effect then continues: funds flow into these bonds, which now bring more yield – and the same funds are withdrawn from shares, causing their prices to fall from the currently rather lofty heights.

This explains the high level of nervousness on the stock markets – and the trend towards the falling indices of leading stock markets. The Swiss leading index SMI, for example, is currently almost 19% lower than at the beginning of the year.

What does this mean for the real estate market?
In a speech, an SNB director put it this way: "A significant tightening of financial conditions could trigger a correction in the real estate market." A correction thereby means a drop in real estate prices of 10% or more. This can also be triggered by higher interest rates, because these weaken the demand for real estate.

The banks demand higher mortgage rates, and the purchase of real estate becomes more expensive, with fewer people being able to afford it. And home ownership is becoming less attractive as an asset class. Buying and subletting is also less worthwhile, because the bonds issued by governments or companies now yield more interest. As a result, demand breaks away – and prices fall.

The essential question here, however, is how much will interest rates have to rise for the real estate market to correct itself. Experts assume that the SNB's key interest rates would have to rise significantly higher for this. Prices have already fallen in a single segment, however, namely that of residential investment properties, i.e. buy-to-let properties.

These are apartments that are bought, for example by insurance companies or wealthy private individuals, and then re-let. Prices have already fallen in some cities abroad. The news agency "Bloomberg" recently headlined: "From Sydney to Stockholm to Seattle, buyers are pulling back, leading to a drop in property prices." An analyst at the UBS bank said it was only a matter of time before prices fall in other cities.

What does this mean for exchange rates?
The currencies of those countries whose central banks raise their key interest rates should tend to appreciate, as the high interest rates attract investors who expect higher returns on their funds – and the demand for the specific currency increases. So much for the theory.

In reality, many other developments play a role. It is not only the SNB that is raising its key interest rates: the Federal Reserve Bank (Fed) had previously already done so in the USA. The European Central Bank (ECB) is also expected to raise interest rates further. And economic prospects can also shift exchange rates or create different inflation rates.

The following trends can currently be observed. The Euro is constantly losing value against the Swiss Franc: it was most recently well below the mark of 96 Rappen, and experts already predict a price of 90 Rappen. And the aggressive interest rate hikes of the US Fed have triggered a strong appreciation of the dollar: the dollar is currently appreciating strongly against most currencies, which the "Wall Street Journal" commented as follows: "The rise in the dollar brings problems for the global economy." For example, many commodities, such as  crude oil, are traded in dollars worldwide. If the dollar becomes more expensive, oil will therefore also become much more expensive for many countries.

What then-US Treasury Secretary John Connally told his astonished counterparts 50 years ago still seems to be true: "The dollar is our currency, but it's your problem."

Are savings interest rates now rising again?
Not yet. This would have to be the case at some point if the key interest rates continue to rise. The comparison service Moneyland.ch has said: "There has been practically no change In the interest rates on bank accounts, which, If anything, actually been falling up to now."

There has only been one case of an increase: Yuh, a subsidiary of Postfinance and Swissquote, has seen an increase. "But that's an exception." But this could change if the SNB actually carries out a major interest rate hike.

Many bank customers see this leisurely pace of the banks as disturbing. On the other hand, banks were very quick to raise their interest rates on mortgages. And the Raiffeisen Switzerland recently calculated how much money will flow to the banks as a result of the SNB's key interest rate hikes. Because the SNB will now have to pay out after raising the interest rate above zero.

In order to pay interest on the sight deposits that the banks currently have with it, the SNB has to spend up to CHF 1.8 billion for every 0.25 percentage point rise. With a key interest rate of 1%, that would amount to a good CHF 7 billion.