06:39 AM EDT, 06/20/2025 (MT Newswires) -- The Swiss central bank (SNB) cut its key policy rate by 25bps on Thursday, noted MUFG.

The market was priced for some risk that the SNB could cut by a larger 50bps but the SNB kept to a more cautious path despite the fact that the SNB has by some distance under-estimated the speed in which inflation has fallen, wrote the bank in a note to clients.

In its first Monetary Policy Assessment last year, the SNB predicted annual inflation in 2025 to be 1.2% and in June 2024 1.1%.

Thursday, the SNB's latest forecast for this year was just 0.2%. Given the Swiss franc's (CHF) role as a safe-haven and given the current global circumstances with elevated geopolitical risks, rates in Switzerland need to be a lot lower in order to deter investors from buying the franc, stated MUFG.

Indeed, in real terms, with modest deflation, the policy rate is modestly positive now with many other G10 central banks now running negative policy rates in real terms, pointed out MUFG. In that regard, it was somewhat surprising that the SNB emphasized the "undesirable side-effects of negative rates that "present challenges for many economic agents."

That certainly gave an initial impression of a reluctance to move the policy rate into negative territory. Investors certainly didn't embrace the decision with Swiss equities closing down 0.7%, although European stocks fell widely as geopolitical risks related to the Middle East remained elevated.

The cut to 0% for the policy rate does in reality bring negative rates back as a potential reality given the SNB since 2022 penalizes banks that hold excess reserves over 18 times its minimum reserves by only paying 25bps less than the policy rate, which will now mean banks are charged. The SNB put the framework in place to encourage lending and maintain liquidity in money markets.

With the SNB forecasting inflation of just 0.2% this year and 0.4% next year, it seems highly likely that the SNB will have to cut again and indeed will likely have to become more active in foreign exchange intervention, added the bank.

Given the zero-bound problem, the SNB is at the mercy of international developments. Worsening global conditions will, for example, see more active rate cuts than currently expected, with the SNB potentially having difficulties matching global monetary easing from here which leads to further upward pressure on the franc.

If the reluctance to turn to negative rates is strong, then the only alternative will be to turn to foreign exchange intervention, noted MUFG. Intra-day high-to-low from May to November last year, EUR/CHF fell 7.5% with limited foreign exchange intervention activity and that stance will likely have to change.

Still, with trade negotiations between the United States and Switzerland ongoing, the scope for foreign exchange intervention may be limited, especially after the U.S. put Switzerland on its "watch List" for currency manipulation. CHF upside risks will likely persist despite the SNB's cut to 0%, according to the bank.