The inflation rate rose up to over 3.3% at the beginning of the year. This prompted the Swiss National Bank (SNB) to raise interest rates from minus 0.75% to the current 1.5%. This has been done in a total of four interest rate steps since June 2022, and another one or two such interest rate steps with a total increase of 50 to 75 basis points are expected to come by the end of the year. The SNB fights an inflation rate of 2% or more with an increase of interest rates, because price stability is one of the most important goals in Switzerland. In doing so, the SNB takes no account of the private or public debt situation. So far so good.
Since 2008, the measure of all open-ended leases: the uniform reference interest rate
In 2008 a uniform reference interest rate was introduced for Switzerland. Previously, the reference interest rate was based on individual parameters such as the variable interest rates of the cantonal banks. The reference interest rate is based on the quarterly volume-weighted average interest rate of domestic mortgage claims. This is rounded to a quarter of a percent in each case. But is this reference interest rate a good thing? We have investigated this question for you.
Various factors determine the rent adjustments
When introduced in 2008, the first reference rate was 3.5%. Subsequently, the interest rates were continuously reduced; in Switzerland, negative interest rates were even common from 2015 to September 2022. The reference interest rate was subsequently reduced continuously, and finally stood at 1.25%. With each interest rate reduction, rents for non-indexed residential leases, which would provide for a minimum rental period of 5 years, were reduced by 3%. However, landlords can offset annual cost increases of 0.5% to 1% per year as well as 40% of inflation.
Cheap money ensured falling rents
Between 2008 and 2022, inflation rate was 2.4% in total, so it was practically non-existent with an average of 0.13% per year. It is interesting to note that the reference interest rate was lowered nine times during this period. The landlords had to reduce their rents nine times by 3%, and at best they were able to counteract this with 40% of the 2.4%, which equals an inflation rate of 0.96%, as well as 7% to 14% cost increases. So the times of cheap money were not only a nice present for landlords, who had mortgages with attractive interest rates, but also for tenants.
«Thanks to the reference interest rate, there was no inflation until 2020.»
Falling rents have almost levelled out inflation in Switzerland
Take a look abroad: In Germany, inflation over the same period was 30.11%, an annual average of 1.77%. In the USA, inflation over the same 14 years was 35.9%. So why did we have such a low inflation rate? A look at the Swiss shopping cart shows that housing and energy account for 25.4%. So with each of the nine reductions in the reference interest rate, the inflation rate was reduced by 0.75%. How often have we been amazed to find that we have felt inflation in a restaurant or at the supermarket, but official inflation has been practically zero. It is certain that the reference interest rate was strongly responsible for the low inflation rate.
LIK-Warenkorb und Gewichte, 2023
Source: BFS – Landesindex der Konsumentenpreise (LIK)
Rising interest rates cause higher rents and higher inflation
But as with every coin, there is always a flip side. And now interest rate hikes are on the horizon as a result of an imminent increase in the reference interest rate to 1.5%. The first interest rate round will hit tenants hard. The cost levels were adjusted for the last time in March 2020. Now, in autumn 2023, in addition to the 3% increase potential for rents, another 40% of an accumulated inflation of over 5% since 2020 which equals around 2.1% - as well as 0.5% to 1% cost increases per year can be added, which corresponds to another 1.8% to 3.6%. In total, rent increases of 6.9% to 8.7% are to be expected in the first round in autumn 2023.
«The first mortgage interest rate round in autumn 2023 will hit tenants hard.»
Secondary effects act as fire accelerators
If one takes into account that about 25% of the national consumer price index includes the cost components of housing and energy, the increase in the reference interest rate by 0.25% would lead to so-called "secondary effects" and thus to a downstream inflation control of about 1.7% to 2.2%. Fortunately, not all landlords will raise interest rates and not all rents were reduced to their former level in 2020. Nevertheless, in the future, with every reference interest rate increase, the secondary effects will fuel inflation like a "fire accelerator".
The inflation spiral can lead to toxic situations
What is the Swiss National Bank going to do? An old adage in monetary policy is "Don't fight the Fed". And that means we have to expect that the Swiss National Bank will in no way take into account your rental costs or your cost or debt situation. Moreover, in addition to rising rents, higher energy costs and spiralling wage prices will lead to higher inflation. Inflation must be fought, and above 2% inflation the SNB takes consistent action. Now this mandate could lead to a toxic situation: Interest rates are raised because inflation is being fought. This leads to an increase in the reference interest rate, which further fuels inflation. A perfect perpetuum mobilie, then, to the chagrin of all market participants.
«The reference interest rate: a perfect perpetuum mobilie for the inflationary spiral.»
The flaw in the system: the reference interest rate has nothing to do with the real mortgage burden
Is the reference interest rate a misconstruction? Yes and no. On the one hand, landlords will be rewarded in future for having fixed their mortgages for 10 to 20 years at 0.8% to 1.2% during the low-interest phase. However, landlords may have taken out very high fixed-rate mortgages in the years 2008 to 2015 and were unable to benefit from the low interest rates, but still had to lower their rents.
An alternative: the indexed rent
The alternative would be to link 100% of the housing costs to the national inflation index, as is customary for commercial leases. This has always been possible, but rental contracts for residential properties, just as for commercial rental properties, can only be linked annually to the development of inflation if the minimum contractual rental period is five years or more. A repeal of this regulation in combination with a move away from the reference interest rate as a benchmark for rent adjustments could perhaps provide more inflation stability. Thus, rents might only have to be raised by 5% (inflation since 2020) instead of 7-9% in autumn 2023. Rents would develop in line with inflation, but secondary effects cannot be dismissed here either.
