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The Swiss central bank is winning a tug-of-war with markets, giving it room to cut interest rates again as the economic growth outlook worsens.

The Swiss National Bank has pushed the three-month rate for borrowing francs in London, or Libor, closer to its target after flooding the financial system with cash. The Libor rate has dropped more than half a percentage point since hitting a seven- year high on Oct. 10 and is now just 10 basis points above the SNB's 2.5 percent goal.

“The fact that Libor is coming down shows they're gradually regaining control,'' said Jan Amrit Poser, chief economist at Bank Sarasin in Zurich. “The SNB is under considerable pressure to cut rates'' and may move as soon as tomorrow.

Swiss central bank Chairman Jean-Pierre Roth wants to revive an economy whose two main growth engines are faltering. The franc's surge to a record against the euro is hurting exports, which dropped for the first time in four years in September, and the financial crisis is pounding earnings at banks such as UBS AG and Credit Suisse Group.

With markets still in disarray, Roth is trying to convince investors the SNB's monetary tools still work.

That challenge was highlighted after Oct. 8 when the three- month rate kept rising even after the SNB joined other central banks in cutting rates. In response, the SNB loaned $54 billion to UBS to shore up confidence in the banking sector and started swap agreements with the European Central Bank to get francs to banks outside of Switzerland.

Early Move?

Now that the three-month rate is closer to the central bank's target, policy makers may move before their next scheduled meeting on Dec. 11, economists say. Poser says the SNB may cut if the ECB reduces its own benchmark tomorrow and Sylvain Broyer of Natixis says a rebound in the franc's exchange rate against the euro may also lead to a reduction.

Investors have increased bets the SNB will lower rates by the end of the year, futures trading shows. The implied rate on the 3-month Liffe contract expiring in December fell to 2.08 percent at 12:48 p.m. in Zurich from 2.55 percent Oct. 15.

“They certainly have more room to maneuver than they did two weeks ago,'' said Fabian Heller, an economist at Credit Suisse in Zurich. “The SNB has had to take a wide range of measures to regain control of their monetary policy instrument.''

Midpoint

Unlike the Federal Reserve, the Swiss central bank targets a three-month market rate that it says is more relevant to the real economy than the overnight rate favored by the Fed. The SNB announces a range for three-month interest rates at each decision along with a main target rate online pay day loans. At the moment, it's the midpoint of a 2 percent to 3 percent range.

Interbank rates took longer to fall in Switzerland than in the euro region after last month's coordinated central bank action. That was partly because of demand in eastern Europe, where banks have used franc-denominated loans to offer cheaper mortgages.

The three-month rate for francs was unchanged seven days after the Oct. 8 moves, compared with drops of more than 10 basis points for similar rates on dollars and euros. In response, the SNB started seven-day currency swaps with the ECB.

“It was important for them to satisfy Swiss franc liquidity needs outside their immediate borders,'' said Eoin O'Callaghan, an economist at BNP Paribas in London.

Swiss Recession

Central banks in Europe are gearing up for a second round of rates cuts after the U.S., China, Hong Kong, India and Japan lowered borrowing costs over the past week. The ECB will tomorrow cut its benchmark to 3.25 percent from 3.75 percent and the Bank of England will reduce its rate by the same margin, taking it to 4 percent, said economists in separate Bloomberg News surveys.

The Swiss economy will probably slip into recession next year, the University of Lausanne forecasts, dragged down by the banking industry. Gross domestic product will shrink 0.6 percent before growing 0.5 percent in 2010, the university's CREA economic institute said Oct. 29.

Financial services account for about 12 percent of GDP and have contributed about 22 percent to growth in recent years, said Bruno Parnisari, an economist at the government's Economy Ministry.

Franc Strength

A stronger franc is making Swiss products less competitive abroad just as a global economic slowdown hurts exports. Switzerland's manufacturing sector contracted for a second month in October, while the European Commission forecasts that the euro region, Switzerland's most important export market, is probably already in recession.

The franc has surged 4.8 percent against the euro since Oct. 1, rising to a record 1.4315 on Oct. 24. It was at 1.5053 at 12:41 p.m. in Zurich.

“Looking at the shake-out we're seeing in the export sector, things are really falling off the cliff,'' said Janwillem Acket, chief economist at Bank Julius Baer in Zurich. “For the SNB, the situation is clear. I see them cutting to 2 percent by the end of the year and then cutting again in March to kick start a turnaround.''

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