After the modest rate cut by the ECB last week, a rate cut by the Swiss National Bank (SNB) on Thursday is a risk scenario. It is believed SNB to remain on hold as the upward pressure on the CHF is limited at the moment. The Swiss interest rates are currently comfortably below the EUR rates across the horizon, thus giving the EUR/CHF support for a move above 1.10 rather than 1.05 in the coming months.

Swiss monetary policy rests on two pillars: the negative deposit rate (at -0.75% since January 2015) and the willingness to intervene on the foreign exchange market to weaken the CHF if needed.

Given the weak economic background, the SNB certainly wants to avoid a re-strengthening of the overvalued CHF. GDP stagnated in Q3 and year-over-year growth slowed down to 0.6%. Since the start of the year, the unemployment rate has risen a bit to 3.4% (from 3.2%). Business climate has recovered from the steep fall in February (after the discontinuation of the CHF floor) but remains vulnerable. The inflation rate is hovering around -1.4% y/y.

The recent rhetoric of the SNB has been that the CHF is "significantly overvalued". It is, indeed, as most long-term models suggest the EUR/CHF fair value above 1.20.

The first instrument to counter unwarranted CHF strength are FX interventions. There have been rumors that the SNB was intervening, but nothing material has been seen in data yet. Sight deposits of domestic banks with the SNB have recently declined - an indication that there were no interventions. The EUR/CHF is close to 1.10 which is said to be the SNB's comfort level.

"We believe the main risk is obviously that the SNB cuts the deposit rate. Policy makers might feel a need to widen the gap between ECB and SNB rates. But with the ECB not as dovish as the market expected, the chances of an SNB cut have diminished too. We attach a probability of 10% to any deposit rate cut from the SNB on Thursday", says Nordea Bank.