In the fall of 2022, monthly EU inflation rates reached their highest levels, with the EU inflation rate at 11.5% in October. In Switzerland, however, inflation was only 2.9%. Given this stark difference, we sought reasons for Switzerland’s low inflation and identified the strong Swiss franc as a key factor. Since then, the franc has continued to appreciate. While this is a positive development for combating inflation, the strong franc is becoming an increasing burden on the export opportunities of Swiss companies.

Strong appreciation of the franc since 2008

The value of the Swiss currency has risen sharply since early 2008. According to the German Bundesbank, one Swiss franc was worth around 0.61 euro at the end of December 2007. By the end of July 2011, is value had risen to 0.87 euro.

The Swiss National Bank responded by setting a minimum exchange rate for the euro on 6 September 2011. The euro had to cost at least 1.20 francs. This corresponds to a maximum exchange rate of 0.833 euro per franc, effectively halting further appreciation.

On 15 January 2015, this minimum exchange rate was discontinued. The Swiss National Bank introduced a negative interest rate of -0.75 percent and expanded the money supply. These two measures helped stabilise the franc, leading to a record profit for the Swiss National Bank in 2017.

Since then, the franc has continued to gain value, reaching a peak of 1.077 euros per franc at the end of December 2023. Afterwards, the Swiss currency lost some value, but appreciated again at the end of July 2024.

Low inflation leads to appreciation of the Swiss franc

Even when energy prices soared following Russia’s invasion of Ukraine, Switzerland maintained significantly lower inflation rates than the US and the EU.

When domestic inflation is consistently lower than the global average, Swiss products become cheaper compared to competing products from other countries. This leads to increased global demand for Swiss products. As exports rise, so does production, employment, and income within the country.

And there is another economic consequence – exporting companies pay their wages, rent, overheads and taxes in domestic currency, so products exported by Swiss companies are paid for in francs. As a result, growing exports increase demand for the franc on foreign exchange markets, driving up its price. In this sense, Switzerland’s low inflation rate contributes to the appreciation of the franc.

Franc appreciation keeps Swiss inflation low

A strong franc influences the development of the inflation rate. A 10 percent appreciation of the franc against the euro is mirrored by a 10 percent depreciation of the euro. This means that prices in Switzerland for products from the Eurozone fall by 10 percent.

If the volume of European products sold in Switzerland is sufficiently large, this has a dampening effect on inflation, lowering the overall price level because of decreasing prices of imported goods. Therefore, the strong franc is a cause of Switzerland’s low inflation rate.

The inflation-dampening effect of the appreciating currency has a positive impact on export opportunities for Swiss companies. This, in turn, boosts production, employment and income.

chart inflation rate and exchange rate relationship

However, the appreciation of the domestic currency has a significant downside. It reduces the price competitiveness of domestically produced goods.

Currency appreciation weakens export prospects

The appreciation of the domestic currency makes products manufactured by Swiss companies more expensive in foreign markets. If, for example:

  • Suppose a production machine made in Switzerland costs 10,000 francs, and the price for 1 franc is 0.80 euro, this machine would cost 8,000 euros in the Eurozone.
  • If the franc then appreciated, so it reached parity with the euro, the Swiss machine would now cost 10,000 euros in the Eurozone without any change in the production costs.

This demonstrates that currency appreciation has two opposing effects on domestic exports. It worsens the price competitiveness of domestic companies, but the inflation-reducing effect improves export opportunities.

Which effect predominates for the Swiss economy? So far, the export-enhancing effects seem to have prevailed.

Two observations support this.

First, in recent years, apart from the first year of the COVID-19 pandemic, Switzerland has consistently maintained a large current account surplus. This means that the entire economy earns more from its international economic activities than it spends. Empirically, exports and imports of goods and service are the largest components of the current account. This means that Switzerland has been able to achieve an export surplus despite a strong currency.

Second, despite the appreciation of the franc, exports of goods and services continued to grow in 2023, albeit more slowly than imports, according to the International Monetary Fund. This has created a slight decline in the current account surplus.

 

Appreciation puts export companies under pressure

Despite the franc’s sharp appreciation, Switzerland has been able to sell its products globally and achieve a significant current account surplus. Nevertheless, the sustained appreciation of the domestic currency is becoming an increasing burden for Swiss companies.

The Swiss association for the country’s technology industry warned of negative effects created by the recent noticeable appreciation in July 2024. In an August 2024 press release, it stated: “The industry has learned how to deal with a strong Swiss franc. But even with harsh savings and efficiency drives, it is not able to defend itself against shock-like appreciation. The rapid appreciation of the franc is therefore a threat to Switzerland as a business location compared to competition from Europe or Japan.”

What happens next?

Different economic theories help explain the level and changes in exchange rates. One prominent theory is the purchasing power parity theory (PPP) of exchange rates. Here, the underpinning core idea is that the exchange rate between two currencies – such as the euro and the franc – should be at a level where one unit of currency can purchase the same quantity of goods in both countries.

As a simplified example, if bread rolls cost half a franc in Switzerland and 2 euros in Germany, one franc should be worth 4 euros – or one euro should be worth a quarter of a franc. Then, with one franc, two bread rolls can be purchased in Switzerland and Germany. For one franc, a person receives 4 euros, which can be used to buy two bread rolls.

These relationships can explain exchange rate changes too. If Switzerland has an annual inflation rate of 1.5 percent, and Germany has an inflation rate of 3.5 percent, the PPP theory suggests that, as a rule of thumb, the Swiss franc will appreciate by about 2 percent annually against the currency of Germany.

Applying these considerations to the actual development of the exchange rate between the franc and the euro, the following three observations can be made on the monthly inflation rates from January 2018 to June 2024.

  • Between early 2018 and summer 2019, monthly inflation rates in the EU were about one percentage point higher than in Switzerland, indicating an appreciation of the franc by about one percent.
  • From summer 2021 to autumn 2023, this difference was significantly higher, suggesting a stronger appreciation of the franc.
  • Since October 2023, the EU’s monthly inflation rate has been only about 1.5 percentage points higher than in Switzerland, decreasing towards June 2024. This indicates that the pressure for franc appreciation is easing.

If differences in inflation rates are central drivers of exchange rates, the annual appreciation of the franc should stabilise at 1% to 2%. Swiss companies have coped relatively well with this in the past. But if there are stronger tendencies toward appreciation, the Swiss National Bank may need to intervene.

It would do so by offering the franc on international foreign exchange markets and purchasing currencies such as euros, dollars and yen, in return. The increased supply of francs would lower its value. That said, the downside of increased money supply would likely be higher inflation in Switzerland.

This economic policy dilemma is inescapable. A targeted devaluation of the domestic currency comes at the expense of price stability at home.

About the authors

Thieß Petersen is Senior Advisor at the Bertelsmann Stiftung, specialising in macro-economic studies and economics. His focus lies on the causes and effects of financial and economic crises as well as the chances and risks of globalisation. Most recently, he worked on the effects of carbon pricing and the benefits of a potential global climate club.

Thomas Schwab, Senior Expert for European economics at the Bertelsmann Stiftung’s “Europe’s Future” programme, specialises in analysing economic policy, with a particular emphasis on territorial inequalities.

Read more on economic topics

The Strong Swiss Franc and 5 other Reasons for Switzerland’s Low Inflation

Scarcity is Here to Stay – Challenges and Options for Action for Europe

A Weak Euro – What Does it Mean for Europe’s Economy?

Is Europe Threatened by Stagflation?

Related Posts: