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Swiss National Bank Raises Rates

The Swiss National Bank raised interest rates by 25 basis points on Thursday and said more tightening was probably needed to secure price stability in the long term as the weak franc could push up inflation.

But while the SNB raised its inflation outlook for 2008, the central bank also said inflation dynamics would slow the following year, indicating that an end to the monetary tightening may be in sight.

Its inflation projection still showed a slight upward trend over time, the SNB said in a statement following the decision to raise its benchmark interest rate target to 2.25%.

"Consequently, in order to ensure price stability in the long term, the SNB will probably have to continue its policy of interest rate normalization," the bank said. "However, any assessment of the inflation outlook is subject to greater uncertainty."

The SNB increased its target band by 25 basis points for the three-month Swiss franc LIBOR rate to 1.75-2.75%, aiming for the mid-point of 2.25%.

At its last few meetings, the SNB had flagged the need for further rate rises by saying it would pursue the gradual "normalization" of rates from low levels if the economy developed as expected.

The SNB also said on Thursday that monetary policy remained "slightly expansionary" at the new rate level, another change from its last policy meeting in December when the central bank said conditions were still "expansionary".

"The probability has risen today that the June rate hike will be the last one," Credit Suisse analyst Thomas Herrmann said.

While the European Central Bank has also raised rates by 25 basis points recently, leaving the door open for further tightening, the U.S. Federal Reserve has been on hold for months and many expect a rate cut will be its next step.

Franc Warning

Markets focused on the raised inflation outlook and the SNB's warning about the inflationary risks from a continued weakness of the Swiss franc.

The franc traded 0.1% higher at 1.6093 per euro, moving further off recent multi-year lows, and interest rate futures showed a higher probability of a 25 basis points hike in June and another later in 2007.

The SNB said the franc's weakness had not stoked inflation so far although it had partially offset earlier rate increases.

"The recent softening of the Swiss franc against the euro may in time lead to stronger price pressure on imported European goods," the SNB said. "A further weakening of the Swiss franc would increase this risk even more."

The SNB raised its inflation outlook for 2007 and 2008, expecting the rate to average 0.5% in this year and 1.4% in next year, picking up to 1.6% in 2009. In December, it had forecast 0.4% for this year and 0.9% for next year.

"The trajectory into 2009 has been cut," Reto Huenerwadel at UBS said. "The data would suggest we are approaching gradually the end of the tightening cycle. We are not far away any longer."

Price pressures have remained well contained with the annual inflation rate at zero in February, far below the SNB's ceiling for price stability of 2%.

The SNB said the dampening effect of lower oil prices should level off by towards mid 2007.

The central bank left its growth forecast unchanged at around 2.0% for 2007.

The SNB also said Swiss economic growth might have been somewhat stronger at the end of 2006 than the 0.5% quarter-on-quarter rate officially reported by the government recently.

The Swiss economy is expected to lose speed this year after growth hit a 6-year high of 2.7% in 2006, though strong economic indicators raised hopes of only a moderate slowdown.

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