EFG International : Why is Swiss inflation low?

The median inflation rate across developed economies rose to 5.6% in February, a 5-percentage point increase from twelve months earlier. In absolute terms, inflation has returned to levels last seen several decades ago. In the eurozone, inflation surged to 7.5% year-on-year in March. However, Switzerland is an exception; although higher than in the recent past, the inflation rate has risen only to 2.4% year-on-year in March.

The CPI baskets are different

To understand why inflation is less affected in Switzerland than in other economies by shocks to commodity prices and supply chain bottlenecks, it is useful to consider the weight of the main expenditure items in the CPI basket. These reflect the spending patterns of households in the different economies. The main differences between Switzerland, the eurozone and the US concern the energy, food, housing excluding energy, and healthcare components.

A closer look at energy prices

The evidence shows that energy prices are fundamental in explaining the differences in inflation, especially between Switzerland and the eurozone. This is almost totally due to differences in the price of electricity. In February and March, the price of electricity in Switzerland rose by only 2.4% year-on-year while in the eurozone it surged by 34.3% year-on-year in February and has likely risen further in March. The gap was even wider for producer prices of electricity: in February, the wholesale price of electricity in Switzerland was 3.1% higher than a year before, while in January in the eurozone the increase was as much as 83.2% year-on-year.

This gap reflects the different technologies used to produce electricity. According to data from the International Energy Agency, less than 1% of the electricity consumed in Switzerland comes from oil and natural gas, while 58% originates from hydroelectric and 34% from nuclear power. By comparison, in the European Union (EU) over one fifth of the electricity supplied is produced with natural gas and over one eighth with coal.

The prices of these commodities, which the EU imports mostly from Russia, have surged over the past 12 months, pushing up electricity prices in the EU. The gap in energy producer prices inflation between Switzerland and the eurozone has widened to unprecedented levels. This is important because a shock to wholesale energy prices affects the production costs of goods and services in all sectors of the economy.

Conclusions and policy implications

The low inflation in Switzerland compared to other industrialised economies is largely explained by differences in the CPI baskets. Relative to the eurozone, the difference in electricity prices stands out. Past increases in wholesale energy prices will push inflation higher in the coming quarters, but in Switzerland the effects will be contained and will not put undue pressure on the Swiss National Bank to normalise monetary policy regardless of the growth outlook.

In contrast, the European Central Bank runs the risk of facing an economic policy dilemma if inflation, already well above its 2% target, were to rise further or remain high for longer than currently expected. Indeed, the empirical analysis of the effects of changes in energy PPI on CPI inflation point to increased inflationary pressures in the next eighteen months.

Finally, the recent energy crisis triggered by Russia's invasion of Ukraine and the sizeable impact this is having on consumer prices requires a policy response aimed at ensuring the safety, accessibility and affordability of energy sources. For Switzerland and even more so for the EU it is imperative to improve the energy efficiency of the economy and to support the development of both the most innovative renewable sources, including solar and wind power, and of those with low CO2 emissions.