CHF rallies sharply as inflation falls, SNB faces dilemma - Rabobank

The Swiss franc's strong performance and soft inflation have raised expectations of SNB action, while the euro's recent strength is now under scrutiny amid economic headwinds and speculation about future ECB cuts, Rabobank's FX analyst Jane Foley notes.

EUR/USD pulls back after April rally

"The safe haven CHF is the best performing G10 currency since US President Trump's Rose Garden tariff address on April 2, having rallied a little over 7% vs. the USD in that period. Yesterday Swiss April CPI inflation registered a softer than expected flat y/y, while the core reading softened to 0.6% y/y from 0.9% y/y the previous month. The near absence of price pressures in Switzerland demonstrates the difficulties faced by the SNB. Policy rates have already been pared back to 0.25% and, while SNB President Schlegel has kept open the option of negative rates in addition to FX intervention to offset deflationary forces, clearly both policies carry risks."

"There is a very strong chance that the SNB will cut rates again at its June 19 policy meeting. Market implied rates point to a 40 bp reduction in rates in a 3-month view, which would put them squarely back into negative territory. SNB policymakers may have been hoping that their proactive approach to rate cuts last year may have allowed them to avoid moving rates back below zero. While it is likely that the outlook for the currency will continue to be influenced by broad market sentiment, following Schlegel's remarks, the CHF is currently the worse performing G10 currency on a 1-day view, in contrast to the safe haven JPY which is standing at the top of the G10 performance table today."

"Having reached a peak close to EUR/USD1.1573 on April 21, EUR/USD has tested the water below the 1.13 level in recent sessions. Last week's softer tone in EUR/USD reflected optimism regarding US trade deals, though this is now showing signs of petering out. Also, since growth risks have been accentuated by trade frictions and to some extent by EUR strength, the market continues to expect further ECB rate cuts starting with another move in June. We see EUR/USD at 1.15 on a 12-month view."