As expected, the Swiss National Bank raised rates by 25bp to a target rate of 2.50%, but the news was a disappointment to traders looking for a 50bp bump and a more hawkish message from the post announcement statement. Despite enjoying some of the best economic fundamentals in the industrialized world, Switzerland has seen its currency depreciate materially against the euro over the past 12 months due to massive carry trades against the unit. The franc, which carries the second lowest interest rate amongst the majors, has been a popular alternative to the yen as a funding currency for the carry trade. Thus, Swiss monetary authorities have been faced with a paradox of facing strong economic growth and a weakening currency at the same time.

Nevertheless, the SNB is not prone to dramatic gestures. Therefore, Swiss monetary authorities opted for the much anticipated 25bp increase rather than the more substantial 50bp hike which would have compressed the interest rate differential between the franc and the euro rather than simply keep it the same. Perhaps one reason that the Swiss policymakers chose the slow and steady approach is the fact that Swiss inflation rate has remained relatively tame. The reading for May registered only a 0.5% year over year growth allaying fears that the weaker franc is importing inflation into the economy.

In its post decision communiqué the bank did note that the rise in Swiss inflation “will be more significant than expected at the last assessment. The reason for this is the softening of the Swiss franc, which has partially neutralized the impact of the last increase in the interest rate. This development in the Swiss franc will push up future inflation by stimulating the economy and increasing import prices.'' Still this was far from the strident, cautionary tone that some market players anticipated, and the franc sold off against the euro as result. For the time being, the SNB appears to be concerned but tolerant of the current exchange rates for the franc. Indeed, as long as long as franc’s weakness does not seep into the inflation gauges, the SNB is likely to follow the 25bp per quarter policy for the rest of the year. If however, inflation begins to approach the 2% level during the summer the chance of a 50bp hike at the next meeting in September will increases markedly.

Boris Schlossberg is a Senior Currency Strategist at FXCM.