Inflation: What can other nations learn from this European outlier?

The median inflation rate across developed economies rose to 5.6% in February, a five percentage point increase from twelve months earlier. In absolute terms, inflation has returned to levels last seen several decades ago, and 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, March’s reading showed inflation had risen only 2.4% year-on-year.

The drivers of surging inflation are generally accepted to be commodity prices, supply chain bottlenecks and tight labour markets. These factors apply to most developed countries, but not to Switzerland where inflation remains low.

Since the mid-1970s, inflation in Switzerland has been close to, but often slightly lower than in the US and Germany. The inflation gap in Switzerland’s favour has widened in recent years, following the eurozone debt crisis, and has surged in the past twelve months.

Different CPI baskets

To understand why inflation is less affected by shocks to commodity prices and supply chain bottlenecks in Switzerland than in other economies, 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 relate to energy, food, housing excluding energy, and healthcare components.

In all three countries, energy prices have increased the most. In Switzerland, however, the rise was less pronounced than elsewhere and combined with the lower weight of energy in the CPI basket, the contribution to inflation is 2.5pp less than in the eurozone and 0.8pp less than the US. The change in food prices, which also impacts restaurant prices, was smaller in Switzerland than elsewhere too, reducing Swiss inflation by 1.1pp compared to the eurozone and 1.3pp compared to the US.

Overall, food and energy explain 95% of the inflation gap between Switzerland and the eurozone recorded in February and preliminary data for March shows that share remained above 90% – and about 40% of the gap with the US.

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 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 has knock on impacts on the production costs of goods and services in all sectors of the economy.

So what? Policy implications for the EU

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.

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.

GianLuigi Mandruzzato is senior economist at EFG Asset Management