Prices for food, clothing and many other consumer goods are rising in Switzerland as they have not for years. The high rate of inflation is particularly noticeable for petroleum products, gas or automobiles. Due to the increase in ancillary costs, more money now also has to be spent on housing.
The term inflation is on everyone’s lips. Therefore, it is useful to be informed about the far-reaching meaning of inflation. What are the economic effects of inflation and how does Switzerland compare internationally? Being well informed makes it easier for private consumers to react prudently and skilfully.
Contents
- 1 The most important facts in brief
- 2 Inflation explained simply
- 3 Inflation in Switzerland in a global comparison
- 4 What factors influence inflation?
- 5 Effects of Inflation from the Perspective of Savers and Investors
- 6 How can I best protect my assets from high inflation?
- 7 The historical development of inflation in Switzerland
- 8 Frequently asked questions (FAQ)
The most important facts in brief
- Inflation refers to the general rate of price increase.
- Switzerland has the highest inflation rate in 14 years and yet one of the lowest internationally.
- Investors can avoid losses by adjusting their investment strategy.
- A low but constant inflation rate around 2 percent is healthy for the economy.
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Inflation explained simply
Inflation is an economic term describing a sustained increase in the general price level for goods and services in an economy over a given period of time.
In Switzerland, it is determined by the national consumer price index (CPI). The index is based on the development of prices in the twelve main expenditure categories of Swiss households. The monthly update is based on the prices of a reference year.
The Harmonized Index of Consumer Prices (HICP) for international comparison
Since 2008, the Swiss Federal Statistical Office has published the harmonized index of consumer prices (HICP) according to the criteria of the European Union. This HICP is an important component of the CPI and is used to compare inflation rates in EU countries, Norway and Iceland.
Inflation as a component of economic policy
In the short term, increasing the money supply and thus raising inflation can be an effective way to stimulate the economy. Demand for goods and services increases as people’s purchasing power is initially increased. In the long term, however, too much inflation is harmful, as real income declines again as a result of inflation. As demand then falls again in the course of time, companies are forced to cut costs. This is often accompanied by a higher unemployment rate.
The consequences of inflation for consumers
As a consumer, you experience the following negative impact in particular as a result of inflation: you can consume less for the same amount of money. Let’s take a cake from the pastry chef as a practical example, which used to cost thirty francs and now costs sixty francs. This means that the franc has lost half of its purchasing power in that case. Other terms for this are devaluation of money or reduction of purchasing power.
Inflation often also gives the feeling that something has become more expensive, which is referred to as “perceived inflation”. Finally, it is not always easy to keep track of which products or services are affected and what percentage increase has occurred.
Likewise, inflation impacts your investment strategy as well as your retirement savings. After all, with a return below the rate of inflation, your retirement savings are effectively devalued instead of increased.
Slight inflation is economically healthy and therefore desired
Inflation has a significant impact on a country’s labor sector, income and wealth distribution, and economic development. When inflation is low, between zero and two percent, it stimulates demand as buyers want to buy or invest with their money. However, when inflation is high, money loses value faster than goods, leading to a decline in real wages. Holders of savings accounts, as well as fixed-income securities such as bonds, are on the losing side, as their assets are worth less. First, the government benefits to some extent, as the real value of its debt falls.
Inflation in Switzerland in a global comparison
Many experts believe that the indicators in both Europe and Switzerland are showing a turnaround and that stronger price stability is to be expected. At 2.8 percent annual inflation, Switzerland is doing quite well. Inflation for domestic goods was as low as 1.9 percent. This means that a considerable part of the inflation is imported as a result of higher prices abroad.
As far as Germany is concerned, it should currently be noted that the lower inflation rate in December was exclusively attributable to lower energy prices. However, this was due to the fact that the government took over the advance payments for gas supplies in this month.
Inflation rates internationally
In order to be able to better classify inflation in Switzerland as well as in the euro area, below are the inflation rates of some selected countries (annual basis, as of 02.02.2023):
- Turkey: 64.27 percent
- Great Britain: 10.51 percent
- Germany: 9.91 percent
- Eurozone: 9.19 percent
- USA: 6.45 percent
- Switzerland: 2.84 percent
When looking at the annual figures, it should be noted that inflation is currently falling in Germany, the USA and Switzerland. This also applies to the average inflation rate in the euro zone.
Crisis in Turkey began after the interest rate cut
Economists attribute the exploding inflation in Turkey to the extremely loose monetary policy of the Turkish central bank. The problems for the country worsened increasingly since the interest rate cuts in September 2021. When inflation is high, central banks should actually counteract it with higher interest rates, but this is not done in Turkey for political reasons. The Turkish lira has depreciated sharply, making imports more expensive – especially in the energy and raw materials sectors.
Low inflation rate in Switzerland – why?
Even though the inflation rate has reached the highest level in 14 years, many Europeans dream of such low inflation.
The main reasons for this are:
- Switzerland has a strong currency: if the franc appreciates, this makes imported goods cheaper for consumers.
- Swiss food prices are decoupled from the world market: Import duties on foreign agricultural products that are also produced in Switzerland protect Swiss vegetable farmers from foreign countries. Only in the event of a poor harvest at home are tariffs temporarily reduced to ensure supplies.
- Electricity requirements are mainly covered by hydropower and nuclear power: Only in winter does Switzerland have to import further electricity from abroad.
- Interest rate level: By keeping interest rates comparatively low, the Swiss National Bank (SNB) prevents capital inflows from exceeding capital outflows and thus dampens inflationary pressure.
- Low government debt: Government debt, measured as a percentage of gross domestic product, is around 95 percent in the euro area in 2021. In Switzerland, it was only 42 percent. This reduces the pressure on the central bank to increase the money supply in order to keep interest rates low.
- Stable economic and banking system: As a small country, Switzerland faces strong competition from surrounding countries. This has always driven innovation. Likewise, the moderate wage-price spiral is currently paying off.
What factors influence inflation?
It is not one factor alone that is responsible for the increase in inflation; rather, it is often a combination of circumstances.
The following factors contribute to increased inflation:
- Money supply: if the money supply, i.e. the money in circulation, is increased more than the production rate, this leads to inflation through a demand pull. In that case, too many francs are available for too few products.
- Demand: If the demand for certain products is greater than the supply, this leads to increased price increases.
- Costs: If labor costs and material costs (for example, for construction materials) rise, these cost increases are passed on to consumers.
- Devaluation: If a country’s own currency is devalued, this makes exports cheaper. At the same time, however, foreign products become more expensive in the country, causing inflation to rise.
- Wage increases: If wages rise too much, this ends up affecting products through high cost increases. This is also referred to as the wage-price spiral.
- Political measures: Political measures can also stimulate inflation. This is the case, for example, when tax subsidies trigger extreme demand for certain products and prices rise as a result when supply is tight.
Background to the current situation
In the euro area, increased demand for classic consumer goods such as flour, pasta or toilet paper emerged at the beginning of the Corona crisis. After retail inventories were depleted, the supply of various raw materials such as wood or metal stalled. Production thus became more expensive. At the same time, the low interest rate policy was massively continued in order to support the economy during the difficult phase of the lockdown. Thus, the money supply was significantly increased.
In spring 2022, the Ukraine war led to a further acceleration of inflation for two reasons:
- The yield losses caused by Ukraine’s agriculture led to food shortages around the world.
- Furthermore, the gas embargoes against Russia led to increased energy costs, which increased production costs.
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Effects of Inflation from the Perspective of Savers and Investors
Inflation affects the value of money by reducing purchasing power, and therefore should have an impact on the financial decisions of savers and investors.
The impact of inflation on savings accounts
Those who choose savings accounts and time deposits face low interest rates of less than one percent when inflation is high, if interest is still paid at all. This means that even the most favorable bank offers have little real value.
Example: Of an initial balance of 50,000 francs, only around 47,000 francs of real purchasing power will be left after two years at an inflation rate of three percent if your money is sitting in accounts without interest. The effects of inflation are often overlooked because most people only pay attention to the nominal figures.
Central banks usually decide to raise key interest rates to counter inflation. However, these key interest rate increases are often not passed on to consumers by commercial banks in the same amount and also with a time lag. This can lead to a negative real interest rate. This is the situation we are currently seeing.
The impact of inflation on credit
Inflation causes debt to lose value, just as assets lose value. For this reason, borrowers with long-term fixed interest rates are the main winners of inflation. However, new borrowers often face higher financing costs due to the effect of increased interest rates to combat inflation.
Strategies for dealing with inflation
It is important for savers and investors to invest their money in a way that provides a return that is higher than the rate of inflation. There are a variety of financial investments that outpace inflation, including stocks and real assets. These investments not only provide a higher rate of return, but also offer some protection when prices for goods and services skyrocket.
The impact of inflation on bond prices
As already seen in the causes, rising inflation is often preceded by a massive increase in the money supply. This means interest rates keep falling. For bonds, this means that newly issued bonds will have a lower interest rate. Meanwhile, existing bonds become more interesting because they still offer a higher interest rate. As a result, prices on the stock markets are rising.
Here, however, investors must not miss the turnaround in interest rates. If interest rates rise again, the prices of the supposedly safe bonds fall. It is also relevant here whether bonds with fixed or variable coupon payments are involved.
Even in times of inflation, you may even be able to make a profit on your assets if you pick the right funds and stocks. If you choose an area of stable value, you can protect your money from loss due to inflation. However, it’s important to know that not all types of real assets offer protection against inflation.
In times of rising inflation, consumer staples stocks, for example, have performed well. These companies are more likely to be able to pass on increased prices to consumers. Stocks on cyclical goods such as cars tend to perform poorly. In these sectors, falling consumption is the first to be felt as a result of higher interest rates.
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The impact of inflation on the real estate market
Since 1998, real estate prices in Switzerland have almost doubled. The market was further fueled primarily by low interest rates on mortgages. Investing in real estate thus became affordable for many, as interest rates for mortgages were at an all-time low.
In the meantime, however, many experts say that the zenith of the real estate market has been reached. Since interest rates started to rise again, demand for real estate has slowed. After all, an interest rate differential of two percent on a mortgage of over 200,000 francs translates into an additional monthly burden of over 330 francs.
Nevertheless, an investment in real estate stands above all for security and a massive slump is therefore not to be expected. Thus, real estate is still an essential building block within a balanced investment strategy. As an investor, however, you should be more cautious in the meantime with pure yield real estate, because above all the costs are rising. As a rule, however, the values of real estate move with inflation.
How can I best protect my assets from high inflation?
As can already be seen in the individual segments, returns above the inflation rate are only still possible with tangible assets. The advantage of tangible assets is that they cannot become completely worthless.
Nevertheless, investors should not do without their safe reserves in the form of savings accounts or call money accounts. This not only prepares you for purchases that are necessary in the short term, but also allows you to flexibly enter the stock market when opportunities arise.
The following investments are therefore particularly suitable as protection against high inflation:
- Equity funds: The risk is manageable with an investment horizon of ten years or more. Broadly diversified and globally invested funds as well as ETFs are best suited.
- Real estate: Owning your own home is a safe and popular component of investment. The security is always determined by the type of financing. You can therefore calculate best if you secure low interest rates for a mortgage in the long term. Furthermore, real estate as a pure capital investment is only advisable if you already have a well-positioned financial investment.
- Precious metals: Especially in times of crisis, gold is a popular investment. Precious metals actually represent a real value that will never expire. Please note, however, that precious metals are unlikely to generate long-term returns. Therefore, only an admixture is recommended.
- Inflation-indexed bonds: There are bonds whose coupon amount is linked to a consumer price index. Thus, the coupon payments increase with inflation and offer a certain protection against it.
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The historical development of inflation in Switzerland
The Swiss national consumer price index (CPI) provides information on the inflation of consumer goods. This index indicates how much these goods have become more expensive compared with the previous month, the previous year or the same month of the previous year. It is a significant economic indicator and is regularly used in politics and economics.
According to figures from the Swiss Federal Statistical Office, there have been the following inflation rates in Switzerland in recent years:
- 2022: 2.8 percent
- 2021: 0.6 percent
- 2020: -0.7 percent
- 2019: 0.4 percent
- 2018: 0.9 percent
- 2017: 0.5 percent
Exploding inflation rates in Switzerland in the 1970s and during World War I – why?
There was a major inflation period in Switzerland during World War I (1914 – 1918). The cause was the enormous cost increases for national defense. The federal government reacted with extraordinary tax increases and an increasing indebtedness on the capital market. But the longer the war lasted, the more the circulation of money increased. The inflation rate rose to over 20 percent. Purchasing power fell, as wage increases could not compensate for this.
Today, the money supply has also been expanded, but to stabilize the exchange rate and not to finance government spending. Thus, this does not create inflation.
The inflation rates in the 1970s of up to twelve percent can be explained by the expansive monetary policy of the USA. Due to the fixed exchange rates, this had worldwide repercussions.
After Switzerland decoupled from the fixed exchange rate system in 1973 and revalued the Swiss franc, inflation rates returned to normal after a certain time.
Since there is no longer a fixed exchange rate system on the international scene, Switzerland does not have to worry about adopting inflation. So a lot has to happen for Switzerland to experience such inflation again. And even if the episodes from the past were to repeat themselves, it would take several years for a comparable situation to occur.
Forecasts assume that inflation in Switzerland will continue to fall
According to the forecast published in December 2022 by the Swiss State Secretariat for Economic Affairs (SECO), consumer prices in Switzerland will rise by 2.2 percent year-on-year in 2023. Inflation expected in 2024 is 1.5 percent, according to SECO. Accordingly, the peak of inflation has probably been passed.
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Frequently asked questions (FAQ)
Can inflation be broken down into individual areas?
As the evaluations of the FSO show, a considerable part of inflation in Switzerland results from price increases of imported goods. Also, consumer goods and energy costs do not develop in the same way. As a consumer, it is therefore advisable to take a look at your “personal shopping basket“. In this way, it quickly becomes clear which investment makes sense and which would be better postponed, if possible.
What options does the state have to respond to inflation?
One of the decisive measures taken by the state is to raise interest rates through the central bank in order to reduce the money supply. Accompanying this, relief packages for citizens are sometimes adopted. For the economy, subsidies may be adopted to mitigate an increase in costs.
In this case, there is already inflation, but it has not yet been publicly recognized. The reasons for this may be government measures that temporarily prevent a price increase.
What is meant by deflation and stagnation?
In economics, deflation means the opposite of inflation. In other words, prices fall significantly and over a longer period of time. This is caused by an oversupply of goods and services. Stagnation is the expression for an economic standstill, where there is no economic growth.
Why does deflation have more serious consequences than inflation?
Sharply falling prices characterize deflation and are an exception. This situation is much more critical than inflation. The reason is that under these conditions, an economic recession usually announces itself, since companies can no longer cover their costs, which would result in unemployment.
