Denmark Has Lessons for Draghi as Official Rates Go Negative

Denmark Has Lessons for Draghi as Official Rates Go Negative
After breaching the zero threshold last month, Nationalbanken’s arsenal of tools to stem krone appreciation is slowly being spent. Photographer: Linus Hook/Bloomberg

As Denmark experiments with official interest rates below zero, European Central Bank President Mario Draghi is getting a glimpse of how extreme monetary policy decisions play out in real life.

Nationalbanken in Copenhagen, which lowered the rate it offers on certificates of deposit by a quarter of a percentage point to minus 0.2 percent on July 5, has become “a test case,” Paul Mortimer-Lee, global head of market economics at BNP Paribas SA in London, said in an interview. “We should take note when our knowledge of this stuff is scarce.”

Danish central bank Governor Nils Bernstein has gone one step further than Draghi in doing whatever it takes to meet his monetary policy goal. For Bernstein, it’s about deflecting a capital influx that threatens to strengthen the krone beyond the limits of its euro peg. For Draghi, negative rates would spur banks to lend. The ECB, which lowered its deposit rate to zero last month, will probably leave rates unchanged at its meeting tomorrow, according to a Bloomberg survey.

“We’re living in extremely volatile times,” Jesper Berg, senior vice president at Nykredit A/S and a former Danish central bank department head who also worked at the ECB, said in an interview in Copenhagen. “Scenarios that were unthinkable just years and months ago are playing out in front of us.”

Denmark is now finding out just what it means to have negative rates. After breaching the zero threshold last month, the bank’s arsenal of tools to stem krone appreciation is slowly being spent.

‘No Limit’

“The Danish central bank has at most one more rate cut at its disposal, and then that tool is used up,” Berg said. “From there on, it’s the foreign reserves. In principle, there’s no limit to how high these can go, but at some point a thing can get so big that that in itself becomes a risk.”

While nations such as Singapore and Hong Kong already hold reserves larger than their economies, printing Danish kroner to buy foreign currency can lead to inflation in the longer term, said Ian Stannard, head of European foreign-exchange strategy at Morgan Stanley in London.

“With all these measures, there are consequences, economic and political consequences,” Stannard said in an interview. “That is ultimately what will determine the sustainability of these policies.”


Denmark’s experiment with negative rates may be most relevant for the Swiss National Bank, whose battle to defend the franc’s cap to the euro resembles Bernstein’s plight. Yet Draghi, who also faces decisions on the ECB’s role in reducing Italian and Spanish borrowing costs, can still get a sense of how banks will react to negative rates from watching the Danes.

There’s a “great risk with this policy,” Mortimer-Lee at BNP Paribas said. “Basically, you’re taxing bank intermediation and at some stage you’re going to discourage bank intermediation and you impede the credit policy.”

He warns that by making banking more expensive, the industry’s ability to provide credit to the economy is diminished.

“There are costs associated with banking,” Mortimer-Lee said. “If you go too far and people start dis-intermediating, the position of the banking sector would be made more difficult, not easier, and that’s not where you want to go. You don’t want to make credit creation more difficult.”

Capital Controls

Bernstein says that there’s no limit on how low the deposit rate can be cut. He’s ruled out capital controls to defend the krone’s peg to the euro, preferring instead to drag conventional tools deeper into what he last month described as “uncharted territory.”

Foreign reserves reached an unprecedented 511.6 billion kroner ($84.6 billion) in June, versus an average of less than 200 billion kroner in 2000 to 2006. Denmark’s central bank defends a 2.25 percent krone band against the euro, though in practice it only tolerates moves well within that range.

The krone traded at 7.4429 to the euro as of 11:48 a.m. in Copenhagen. That compares with a close of 7.4414 on July 5, the day Nationalbanken cut rates.

The bank, which doesn’t hold scheduled policy meetings, adjusts interest rates in tandem with the ECB to steer the exchange rate through the rate differential. Currency market interventions are an additional tool.

Capital Influx

Denmark has fought off a currency influx driven by investor dismay over the euro zone’s failure to stem its crisis. Even negative yields have failed to keep capital out as the prospect of a euro-zone breakup underpins demand for kroner.

The yield on Denmark’s benchmark 10-year note traded 21 basis points lower than similar-maturity German bunds today. The Nordic country’s 3 percent note due November 2021 rose four basis points to 1.12 percent. The yield on its two-year note was at minus 0.281 percent.

Denmark’s fiscal restraint and current account surplus have also attracted investors alarmed at swelling debt burdens inside the single currency bloc. The government of Prime Minister Helle Thorning-Schmidt will post debt of about 40 percent of gross domestic product this year and next, less than half the euro-zone average, the European Commission said in May.

Demand for the krone is unlikely to abate any time soon, said Kasper Ullegaard, head of fixed income at Sampension AS.

Getting Burnt

“By this stage in the crisis, investors are used to getting burnt if they don’t buy the safest paper, so that will continue to attract them to Denmark,” he said.

According to Stannard at Morgan Stanley, “the pool of safe havens in Europe is shrinking. While we see the pressure within the euro zone continue to build, the safe havens will still gain support,” he said.

The implied probability of a country leaving the monetary union is 59 percent for next year, and 66 percent by the end of 2014, based on bets at Citigroup Inc. said last month there’s now a 90 percent chance that Greece will leave the euro in the next 12 to 18 months, spelling prolonged economic weakness and spillover for the currency bloc.

Though the Danish central bank “hasn’t yet run out of tools, they will if this drags out,” Henrik Drusebjerg, Copenhagen-based senior strategist at Nordea Bank AB, said in an interview. “At some point, they will.”

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