By Neil MacLucas 

ZURICH--Switzerland's economy contracted for the first time in 4 1/2 years in the first quarter as the strength of the Swiss franc hit foreign demand for the country's pharmaceutical and machinery products.

Gross domestic product in the three months through March fell 0.2% from the previous quarter and was 1.1% higher from the same period last year, the Federal Department of Economic Affairs, Education and Research said. The result was below economists' expectations for a quarterly contraction of 0.1% and annual expansion of 1.6%.

Economists had expected the Swiss economy to shrink after the Swiss National Bank in January ended a 3 1/2-year policy of capping the franc at 1.20 per euro. The eurozone is the Alpine country's main trading partner.

The franc cap had helped keep Swiss export prices competitive, but the currency's gain of around 12% since the central bank scrapped the cap has pegget back sales to the eurozone which buys almost half of Switzerland's exports.

With the franc around 1.0350 against the euro compared with 1.2020 at the start of the year, a further contraction in the current quarter cannot be excluded, according to Eric Scheidegger, head of Switzerland's Economic Policy Directorate.

"The export sector, as well as the retail and tourism industries have reacted quickly to the strength of the franc, and I think it's fair enough to expect further weakness in the Swiss economy," said Mr. Scheidegger.

Growth in private consumption and investment in equipment failed to offset the decline in virtually all sectors of the Swiss export sector, from luxury goods to industrial equipment and pharmaceuticals.

Swiss goods exports dropped 2.3% in the quarter from the previous three months, with pharmaceutical, chemical and industrial machinery sales hit particularly hard by the strong franc.

Analysts said the first-quarter slowdown was a "logical consequence" of the central bank's move to allow the franc to float freely, and follows 13 consecutive quarters of economic expansion.

"The blows to the export and tourism sectors all fit with the fallout from the strong franc," said Karsten Junius, economist at J. Safra Sarasin.

The Swiss economy has underperformed its neighbors, with European Union economies notching up aggregate growth of 0.4% in the first quarter from the previous three months and expanding 1.4% from the first quarter last year.

Switzerland's Department of Economic Affairs has more than halved its forecast for full-year growth since the SNB decision, and will update its GDP, inflation and unemployment forecasts on June 16.

The Swiss central bank, which acknowledged the move to allow the franc to float free will pose considerable challenges for the economy, will review its growth projection of around 1% on June 18.

Write to Neil MacLucas at neil.maclucas@wsj.com<mailto:neil.maclucas@wsj.com>

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