Strong 2010 momentum to fade into 2011

We believe stronger than expected Q2 GDP in Switzerland (+0.9% qoq) coming on the heels of a large upward revision to the first quarter (1.0% qoq vs. +0.4%) warrants an upward revision to our 2010 GDP forecast. We now expect the Swiss economy to expand by 2.7% instead of 2.3%.

For 2011, more modest growth prospects in the euro area (1.4%) and the US (1.8%), together with a stronger CHF, are sufficient to shave 0.3ppt from our GDP forecast to 1.8%. We maintain the view that the Swiss National Bank (SNB) will be tempted to hike interest rates for the first time in December, when we pencil in a +25bp hike to 0.5%. However, with inflation on a modest upward trend, we think that the SNB will likely be cautious thereafter. This would translate into spaced out rate hikes, with a second 25bp rise to 0.75% in June and a third 25bp move to 1.0% in December 2011.

GDP expanded by 3.8% annualised in H1 2010

Swiss GDP grew by 0.9% qoq in the second quarter, exceeding the 0.8% qoq consensus forecast. There was also a sizeable upward revision to the first quarter numbers, with GDP rising 1.0% qoq (4.2% annualised) instead of the previously reported 0.4% qoq. The Swiss economy therefore grew by 3.4% yoy in Q2 (Mkt. 2.6%) after an upwardly revised 2.3% yoy reading in the first quarter.

Investment-driven upswing boosted Q2 GDP

Splits showed that final domestic demand contributed 0.4ppt to the 0.9% GDP uptick. All of it came from the investment component, with a 2.1% qoq rebound in Q2 after a 2.2% slide in Q1. Private consumption was flat and government spending fell 0.1% qoq. Inventories added an impressive 1.5ppt to the quarterly GDP increase, with net trade subtracting 1.1ppt as exports rose by 1.7% qoq (14.6% yoy) but imports surged by 4.7% qoq (12.1% yoy). The Swiss government announced that it may raise its 1.8% growth forecast for 2010 (1.6% in 2011). Revised projections are scheduled for release on 21 September.

Solid retail dynamics underpinned by low inflation

Real Swiss retail sales rose by 3.4% yoy in July, an outcome only slightly softer than the 3.7% Q2 average. In seasonally adjusted terms, real retail sales grew by 0.7% in July suggesting that the third quarter will likely see a seventh successive gain. The low inflation backdrop is underpinning consumption. The headline CPI rate fell from 0.4% yoy in July to a six-month low of 0.3% in August, confirming that there are no significant inflationary pressures in Switzerland.

SNB rate hike opportunity will depend on FX

Swiss central bankers see only a small risk of deflation in the short term, but continue to argue that the monetary policy situation remains complex with the SNB monitoring the Swiss franc very closely. The steady appreciation of the currency is keeping a lid on imported price inflation. The main risk to our forecast is that the SNB stays on hold for longer as forward-looking indicators turn.