Our Core Thesis

The above Core Thesis is a very fitting analysis and a likely prediction as far as a continuing long-term upward trend of the CHF is concerned. I am less convinced however the Switzerland will not accept higher inflation as a way out since the SNB has already shown itself to be pragmatic in the face of extraordinary circumstances and when backed by the political and economic establishment.
The all-important question is what kind of inflation it is going to be. Wage-driven inflation might look like an acceptable solution in the future while the credit-fueled variant will not (and is not necessary given the strength of the Swiss economy) and is therefore actively combated by the SNB.
Let’s look at the very similar situation of Germany first. Both the SNB and the Bundesbank have years of cumulative current-account surpluses on their balance sheets, in the German case as a TARGET-2 balance and in the case of the SNB as foreign-exchange reserves. The surpluses ended up there when, during the financial crisis, the banks started to deleverage and companies repatriated cash from their peripheral operations to the safety of their homeland (private capital flight played a negligible role in comparison if it happened at all). The only difference between the two countries is that Switzerland decided not to let the CHF appreciate while Germany as part of the Euro system had no such choice. How is Germany going to adapt? Through wage increases and a rather ill-designed increase of pension benefits (ill-designed because it limits active years instead of increasing them – benefits had better be increased in monetary terms). How will Switzerland adapt? Wage increases would in my opinion not be the worst option.
This path has implicitly been chosen by the people in the recent vote on tightening of immigration. Consumer-price inflation will in this case be concentrated in the non-tradeables because tradeables move rather freely in the Single Market of which Switzerland is a member for all practical purposes.
Wage-driven inflation will also benefit the active generations vs. savers and retirees which does not seem unfair given the subsidizing of retirees in the current pension system with its too high pension payments. The SNB would obviously be pleased with this outcome because it is easier to sell missing the inflation target rather than announcing the destruction of its equity. But the SNB cannot force the private sector to increase wages – only labor scarcity and public employers can.
Will this be enough? Probably not and the SNB will have to book some foreign-exchange losses. Whatever the final policy mix will turn out to be, I would not be surprised to see wage increases as an important element. What does this all mean for the export sector? Whatever the mix of welcome wage inflation, not so welcome credit-fueled inflation and currency appreciation will be, the input costs of the export sector will go up. After this sector has been bailed out by the SNB and now has enjoyed a few years protected from reality, it is now time for the export sector to pay back the SNB by readying itself for the coming, inevitable adaptation: by investing in productivity, cutting cost and focusing on the highest-margin products. Unfortunately, the CHF floor forces the SNB to communicate that the CHF is over-valued, a message readily echoed by the media. The very real danger is that the export sector believes this out of convenience instead of working on their fitness now more than ever. As an afterthought: A further, mitigating policy option to take pressure off the SNB would be any policy that makes investing abroad easier. First on my mind are investment restrictions on pension funds.

JP Morgan’s comment on the Monetary meeing September 2014:

It remains to be seen whether the SNB will cut the deposit rate as early as the quarterly meeting on September 18th. The dilemma for the SNB, which presumably why it has not acted on interest rates since before the floor was introduced, is that a further easing is interest rates is not necessarily appropriate for the Swiss economy, not least as this would run counter to the SNB’s efforts to ensure financial stability through a slowing in credit growth and house prices. Failure to cut this week would probably ensure an outright test of 1.20, so the stakes are high. Should the SNB cut we would raise our forecasts for EUR/CHF for a couple of quarters, albeit still retain a longer-term downward trajectory for the cross. The Swiss economy is fundamentally healthier and less deflation-prone than the Euro area, so it is not obvious to us that the SNB will be in a position to match ECB easing for as long as is necessary for the ECB to reflate the Euro area.