EUR/CHF: Domestic inflation continues to edge lower

CHF was among the big losers recently with EUR/CHF increasing 1.5% on 5 March. While Swiss inflation slightly exceeded expectations, this did not help the Swiss franc. Core inflation was 0.9% year-over-year and headline inflation came in at 0.3% year-over-year. Q1 inflation is expected to reach the SNB’s expectation of 0.3% year- over-year.

A drop in the reference interest rate for rents has helped domestic inflation move lower. This should keep the SNB on track to deliver a 25bp decrease at the next meeting on March 20.

The market reduced its price slightly, setting it at 21bp for the meeting and 33bp for the rest of the year.

Global developments are now taking centre stage.
As a result, domestic Swiss data releases appear to hold the least significance for the EUR/CHF currency pair.

The main factor for the cross will be whether recent optimism around the EUR continues. This optimism is driven by a major shift in Germany’s fiscal policy and debt rules. It also depends on whether risk appetite remains strong.

Bond market sell-off: EUR/USD and EUR/CHF in focus

A global bond sell-off, driven by Germany’s ambitious spending plans, continued its run. These plans are likely to reshape the economic outlook of the eurozone and have already had a significant influence on the euro forecast, lifting pairs such as the EUR/USD and EUR/CHF.

European bond yields have continued to rise, driven by Germany’s announcement of a huge $500 billion investment in infrastructure and defence. While bond yields of other EU countries have also increased, the benchmark 10-year German yield has continued its steep increase to 2.929% before slightly easing. This has caused the euro to rise, increasing EUR/USD to 1.0780 and pushing the euro higher against the franc, yen and pound.

The relationship between EUR/CHF

The euro and the Swiss franc have a strong correlation in the forex market due to the widespread use of the euro as a reserve currency. The euro is the second most traded currency globally, and when combined with the Swiss franc, it creates a very liquid trading pair.

The EUR/CHF exchange rate reflects the number of Swiss francs required to buy one euro. For example, at a rate of 1.0500, one euro is equivalent to 1.05 Swiss francs.  

Because of its significant trading volume and regular market movement, the EUR/CHF is popular with traders. But compared to other currency pairs, you need more patience to trade due to its lower volatility.

As of November 2024, the correlation between the two currency pairs is negative 98.4%. This shows an inverse relationship, meaning that when the EUR/USD rises, the USD/CHF usually sells off, and vice versa.

How EUR/CHF works

The currency pair EUR/CHF is driven by two currency pairs: USD/CHF and EUR/USD. A correlation of 98.4% is almost perfect for two separate and distinct financial instruments. However, trying to capitalise on the interest rate differential by arbitraging the two currencies isn’t always successful.

The most dominant currency is the U.S. dollar, and almost 90% of all currency transactions involve the U.S. dollar. As the U.S. economy is the biggest in the world, the strength of the U.S. dollar impacts many other countries. The strong relationship between the EUR/USD and USD/CHF is due to the U.S. dollar

in both currency pairs but the closer ties between Switzerland and the eurozone make the relationship between EUR/CHF stronger.

Switzerland has strong political and economic ties with its larger neighbours and is surrounded by other eurozone countries. These connections began with the 1972 free trade agreement. Over 100 bilateral agreements followed, which allowed the free flow of Swiss citizens into the European Union’s workforce and the gradual opening of Switzerland’s labour market to EU citizens.

What influences the EUR/CHF exchange rate

A number of factors influence the EUR/CHF exchange rate, including economic indicators to geopolitical events. Like all assets, the value of a currency fluctuates according to supply and demand.

Central banking policies

The monetary policies of central banks have an important impact on how the EUR/CHF moves. Their policies have a direct impact on the exchange rate as the Swiss National Bank ensures price stability for Switzerland and the European Central Bank ensures the same for the eurozone.

Interest rates and exchange rates

Changes in interest rates have a direct impact on the EUR/CHF currency pair’s movements and exchange rate. As higher interest rates attract foreign capital and increase demand for the domestic currency, they have a direct impact on currency values and exchange rates.

Central banks use interest rate changes to influence both inflation levels and exchange rates, which in turn affects the appeal of their currencies in the forex market.

Economic indicators

Economic indicators have a big impact on the EUR/CHF currency pair. Exchange rates are influenced because foreign traders move their capital away from risky regions and towards stable regions with strong economies. Positive reports on the economic growth of the eurozone or its member countries can boost the strength of the euro in the forex market.

The Gross Domestic Product (GDP) is a key metric that influences changes in the EUR/CHF exchange rate. As Germany is the biggest economy in the eurozone, changes in its GDP often have the biggest effects on the value of the euro. As a result, fluctuations in GDP can lead to changes in traders’ perceptions of the euro, which can affect how much it is worth in relation to the Swiss franc.

Safe-haven status

The safe-haven status of the Swiss franc greatly influences the EUR/CHF currency pair during periods of market volatility.  Traders looking to reduce risk often move towards assets like the Swiss franc, U.S. dollar, and Japanese yen, until market conditions settle.

Historical events like the global financial crisis of 2008 and the European debt crisis of 2009-2013 caused substantial money flows from impacted regions to Switzerland, highlighting its role as a safe haven.

Forecast: EUR/CHF breaks out

With the EUR/CHF breaking key levels the previous week, the euro is creating a stir ahead of the European Central’s rate decision. Investors are still coming round to Germany’s decision to release hundreds of billions of euros for infrastructure projects and defence. This big change may not only boost Germany’s economy but also impact its neighbours in the eurozone.

Thanks to the significant rise in the euro, the EUR/CHF has broken out decisively, exceeding its 200-day moving average and overcoming key resistance at 0.9500-0.9517. While the overall trend is upward, some resistance is expected around 0.9600. the next logical step seems to be a shift towards 0.9700, with parity not completely ruled out in the future.  

Summary

For forex traders, the correlation between the euro and the U.S. dollar and the Swiss franc and the U.S. dollar is crucial. Successful trading is significantly influenced by the interaction of these two powerful relationships. But it can be easily impacted by monetary and political policies.

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