KOF Economic Forecast for Summer 2019: Industry Bolsters Swiss Economy

The Swiss economy performed well at the beginning of 2019. The first quarter saw the highest growth rate in gross value added – adjusted for the revenues from major international sporting events – since autumn 2017. Moreover, the initial estimate for the fourth quarter of last year has been revised upwards by an annualised 0.7 percentage points. KOF has therefore raised its GDP growth forecast for 2019 by 0.6 percentage points to 1.6 per cent (1.8 per cent excluding sporting events). It expects GDP to increase by a similar order of magnitude next year.

However, the economic environment in Switzerland continues to be plagued by uncertainty. Although the global economy was growing robustly at the beginning of 2019, its growth prospects for this quarter and the next few quarters are fairly subdued, with risks remaining on the downside. There is, for example, a risk that the trade conflict between the United States and China could escalate further. The United Kingdom’s exit from the European Union (EU) has been postponed until the end of October. The nature of Britain’s future relationship with the EU after its departure remains uncertain. Switzerland too has delayed a decision on its future relationship with the EU, even though the Swiss Federal Council has recently been trying to give the impression that the obstacles to signing a framework agreement have diminished. Although Switzerland’s new corporate tax reforms have been approved by the country’s voters, this has not totally removed the uncertainty for Swiss companies because the impact of these reforms depends largely on how they are implemented by the cantons, which has yet to be decided.

Wage growth set to gradually gather pace

Private consumption will again grow only sluggishly in 2019. This will probably be caused by low population and wage growth rates. Real wages fell by 0.4 per cent in 2018 according to the Swiss Wage Index (SWI) despite the fact that GDP grew by 2.6 per cent, after 2017 had seen no real wage growth at all. Wage growth is set to gradually gather pace over the coming quarters. Firms grew in 2018 and managed to improve their profitability after a few tough years. Furthermore, growing shortages have appeared in the labour market, with the lack of skilled workers in certain professions strengthening wage earners’ bargaining power.

KOF currently expects nominal wages to rise by 0.7 per cent in 2019 according to the SWI. After adjusting for inflation, however, this translates into only a modest increase in real wages. Nominal and real wage growth is then forecast to be slightly stronger in 2020. This is likely to boost consumer spending, which is set to rise more sharply from 2020 onwards.

The healthy state of the labour market in 2018 continued unexpectedly at the beginning of 2019. Full-time equivalent employment is growing at above-average rates. The unemployment rate according to the definition used by the International Labour Organization (ILO) has been falling for the past year and is now 4.6 per cent on a seasonally adjusted basis, having previously fluctuated around 5 per cent for years. KOF expects to see a further – albeit modest – reduction in the unemployment rate according to the ILO definition over the forecast period. Full-time equivalent employment is forecast to grow by 1.3 per cent in 2019. However, this remarkable increase is mainly attributable to the strong growth achieved in the first quarter of 2019. Significantly lower quarterly growth rates are expected over the further course of this year.

Industry returning to more normal profit margins

The currently healthy state of the Swiss economy is mainly attributable to manufacturing. Since the Swiss franc has weakened in recent years and, adjusted for inflation, has reached a level similar to that prior to the abolition of the euro minimum exchange rate, manufacturing has again become more competitive and is generating more normal profit margins. With the exception of firms supplying the German car industry, most Swiss exporters operate in production areas that are not affected by higher US tariffs. There is therefore a good chance that demand for these companies’ products will continue to rise. The pharmaceutical industry in particular has little cause for concern. However, the luxury segment of the watch industry could experience a drop in demand from China, the United States and other countries.

Switzerland’s foreign trade delivered a robust performance in the first quarter of 2019. Exports of goods and services grew at an annualised rate of 8.4 per cent on the back of the unexpectedly strong economic performance of key markets in North America and Europe. Supported by strong domestic demand and high export growth, total imports increased sharply by 8.3 per cent. Export growth is likely to level off over the coming quarters.

Growth in construction investment slowed in 2018, with the fourth quarter being particularly weak. The first quarter of 2019 witnessed a sharp upturn thanks to favourable weather conditions. However, the slowdown in economic growth and the build-up of excess capacities in the residential sector are causing weak demand, rising vacancy rates and falling property prices. These factors are acting as a drag on construction investment growth during the forecast period.

SNB set to maintain interest-rate differential vis-à-vis euro area

Interest rates are tending to fall even further at present while the Swiss franc’s exchange rate is strengthening. This can largely be explained by the heightened uncertainty about the performance of the global economy going forward. KOF expects interest rates in all of the major currency areas to remain on hold for at least the next twelve months. As the Swiss National Bank (SNB) is set to follow the policy of the European Central Bank (ECB) in order to maintain the interest-rate differential vis-à-vis the euro area, KOF does not expect to see any interest-rate hikes in Switzerland before the second half of 2020. The fact that domestic inflationary pressures remain subdued supports this assessment.

Forecasting risks

The greatest economic risk to Switzerland remains the potential for trade conflicts to escalate – especially the danger that they could spread to further Swiss export destinations. In the EU the most serious threat to the economy is currently posed by Italy. This country’s lacklustre economic performance over a number of years persists, while its budget deficits continue to inflate its public debt. International economic or geopolitical turmoil could trigger extreme currency volatility. Any flight to safety would in all probability cause the Swiss franc to appreciate again, which would not be welcomed by Switzerland’s exporters.