Why investors want to know how the SNB makes its decisions

A few days ago, it was that time again: the Swiss central bank conducted its monetary policy assessment. The title of the press release was as dry as ever: "Central Bank leaves SNB key interest rate unchanged at 0%". But why should a decision to leave the key short-term interest rates unchanged be relevant, let alone reported by all the media?

The explanation begins with the significance of the key short-term interest rates. It is the starting point for financial transactions within the Swiss franc currency area, which includes Liechtenstein. Or, to put it more simply: it is the price of the Swiss franc.

Interest for banks

However, this price is directly relevant only to commercial banks that hold funds with the central bank. They receive the SNB interest rate on these funds. Why do they deposit their money with the central bank at 0%? Firstly, because they are obliged to do so (minimum reserve requirement), and secondly, because the money is safer with the central bank than anywhere else and they therefore do not need to set aside shareholders’ equity. Interest is calculated daily and paid out once a month.

Like a cascade, this rate then flows through the economy. Overnight interbank lending is based on the key interest rate. These transactions then serve as a benchmark for the Saron, the Swiss Average Rate Overnight. Various short-term financial transactions in which interest rates play a role are based on this SARON. Homeowners, for example, are familiar with the SARON mortgage loan: under this arrangement, borrowers pay the SARON plus a mark-up calculated by the bank on the basis of credit risk. This interest rate is reset every 90 days.

But key short-term interest rates are also significant for longer-term interest-bearing transactions. However, for terms to maturity of three, five or ten years, it is not the SNB that sets the interest rate directly but rather supply and demand in the interest rate market. Government bonds serve as a benchmark; on top of this comes a risk premium for the company or individual borrowing the money, as well as a term premium, which increases the longer the term to maturity.

The question remains as to why the SNB raises or lowers the key interest rate. Its mandate is as follows: the central bank must ensure price stability. This means that inflation must be 2 per cent or less. By setting interest rates, it can influence the economy. If the economy is performing well and this leads to rising prices, it raises interest rates. Conversely, it will lower interest rates if it considers the economy to be stagnating. Of course, striking this balance is difficult, and even central banks cannot predict the future. By informing the public of how it assesses the situation, it is being accountable.

Add to agenda

Why should investors take an interest in the announcement on key short-term interest rates? Because it concerns the cost of capital. This influences how much interest you earn on debentures issued in Swiss francs. Interest rates also affect the currency; investment capital normally seeks out currencies with higher interest rates. However, as a safe haven, the franc is in high demand, so the interest rate differential compared with other currencies is not particularly relevant. Furthermore, anyone calculating the present value of a company’s future cash flows will arrive at lower figures when interest rates are higher, and vice versa. Valuations rise or fall accordingly.

To see the bigger picture, it is therefore essential to mark the four dates of the SNB’s monetary policy assessment in your calendar.

Legal notice: You can find the legally required information on financial analyses at https://www.vpbank.com/en/legal-notice.