Deflation race between Swiss franc and Euro leads SNB's rate stance and EUR/CHF path

The long-term path for EUR/CHF will be determined by who sees inflation first: Switzerland or the Euro area.

Although, the CPI in Switzerland increased 0.2% in February of 2016 over the previous month. But Swiss franc is still sensing deflationary pressures year-on-year terms, Swiss consumer prices went down -0.8% on the year in February of 2016, easing from -1.3 percent decrease in the previous month.

The euro area falls in deflationary pressures, Consumer prices in the Euro Area decreased 0.2 percent year-on-year in February of 2016, following a 0.3 percent rise in the previous month and lower than market expectations, preliminary estimates showed. The inflation rate turned negative for the first time in five months, falling the most in a year as oil prices weight.

As a result, the ECB today surprised in rate decision by reducing its benchmark interest rate and cut its deposit rate into negative territory, in order to address economic slowdown and boost up inflation in the euro region (reduced interest rate from 0.05% to 0.0% while forecasts were remain unchanged, while deposit rates were also reduced by 10 bps to keep it at -0.4 in line with forecasts).

The SNB's inflation forecasts extend out to Q3 2018, but extrapolating the last year of forecasts, it would take until Q3 2019 to reach the 2% target.

The 1.2% conditional inflation forecast for Q3 2018 also assumes rates stay at -0.75% throughout the forecast period. That weak inflation outlook should allow the SNB to keep its nominal rates lowest in the world.

Doors are open for SNB policy action but it does not seem likely to cut rates further in an attempt to push EUR/CHF higher, rather it may use its remaining policy tools (further cuts and/or actual intervention) to prevent EUR/CHF from trading much lower.