Here’s an example of some of the twists and turns that economies with negative rates might need to gird for.
Seven years after Denmark’s property bubble burst, house prices in the country’s biggest cities are already higher than at any point in recorded history. Meanwhile, banks are trying to figure out how to navigate their way through the first auctions that will probably result in investors paying homeowners to borrow.
These are the clearest signs that efforts to defend Denmark’s euro peg with an unprecedented injection of cheap money may be distorting some corners of the economy. The central bank’s benchmark deposit rate is minus 0.75 percent after four cuts this year. Yields on government bonds are negative for maturities as long as five years. Mortgage-bond yields trade below zero for maturities up to three years.
“Perhaps it’s okay to have negative rates, but there are a lot of other problems that derive from that,” Sune Worm Mortensen, a director in charge of residential mortgage strategy at Nykredit Realkredit A/S, said in an interview.
In the leafy Copenhagen district of Frederiksberg, an average 140 square-meter (1,500 square-foot) house costs 1.8 million kroner ($275,000) more today than it did in 2009, according to Nybolig, a unit of Nykredit. That’s about 676,000 kroner more than at the height of Denmark’s real estate boom, which topped in 2007 and burst a year later. House prices plunged about 20 percent from their peak through to their 2013 trough, triggering a community bank crisis and sending the economy into a recession.
Denmark’s Financial Supervisory Authority is “continually monitoring the development of house prices,” Director General Ulrik Noedgaard said in an e-mailed response to questions.
Danes are now about to benefit directly from the record-low rates. Mortgage banks estimate short-term bonds for about 170 billion kroner will be refinanced in auctions starting in the final week of February. According to Nordea Bank AB, about 95 billion kroner of that will be in one-year loans, for which bonds already trade at negative yields.
“It’s going to be one of the most interesting auctions in a very long time due to the krone crisis,” Anders Aalund, chief analyst at Nordea Markets in Copenhagen, said by phone.
Realkredit Danmark’s 1 percent mortgage bond due April 2016 traded at about minus 0.6 percent on Friday, according to data compiled by Bloomberg. Its yield has been below zero since the end of January.
“Nykredit and Nordea have stopped offering these loans and the overall issuance is low, so liquidity has been very limited,” Aalund said yesterday. “That means the auction prices are very difficult to predict.”
Nordea Kredit, the mortgage unit of Nordea Bank, said on Friday it will again start selling loans backed by three-year bonds. It had withdrawn the product earlier this month after yields went negative. The bank won’t resume sales of loans backed by one-year bonds.
Borrowers will still end up paying their banks for the loans even at negative interest rates, due to the fees imposed to process the mortgages. Interest rates probably won’t go far enough below zero for borrowers to earn money on their loans, Lise Bergmann, Nordea’s housing economist, said.
Borrowers’ rates on one-year bonds may fall as low as minus 0.25 percent in the refinancing auctions, according to Christian Heinig, chief economist at Realkredit Danmark, the mortgage unit of Danske Bank A/S. That includes a refinancing fee.
Distortions in the housing market shed some light on the tight-rope act central bank Governor Lars Rohde needs to pull off. Since the Swiss National Bank abandoned its ties to the euro on Jan. 15, Rohde has fought back speculators betting Denmark will be next to jettison its three-decades-old currency peg. That’s forced him to unleash an historic wave of measures to deter investors from holding krone assets, including suspending government bond sales.
To continue defending the peg, the central bank is “not ruling anything out,” spokesman Karsten Biltoft told Bloomberg on Thursday. Rohde said earlier this month there’s no limit to how low rates can be cut or how high foreign reserves can rise to save Denmark’s currency regime.
The extreme measures are playing havoc with the accounts of Denmark’s financial institutions, which pay the central bank to hold their deposits. So far, only corporate lender FIH Erhvervsbank A/S has decided to pass on that cost to its clients. Danske Bank A/S, the country’s biggest lender, says it will probably wait at least a year before deciding whether to do the same with retail customers. Chief Executive Officer Thomas F. Borgen said in an interview earlier this month he’s girding for negative rates lasting as long as two years.
While savers are being pummeled, the rewards borrowers stand to reap are being curtailed by some mortgage banks, which aren’t prepared to go ahead with issuance at negative rates.
Nykredit and Nordea say it makes no sense to offer new loans backed by bonds with negative rates, while Realkredit Danmark, the mortgage unit of Danske Bank, says it will continue issuance.
The FSA has already adopted measures to prevent bubbles in the housing market, with many of the new rules addressing shortcomings perceived to have fanned Denmark’s most recent housing collapse. Part of that framework is a requirement that home buyers provide a minimum deposit of 5 percent of a property’s value, Noedgaard said.
The FSA is in dialogue with the Systemic Risk Council, a unit inside the central bank that Rohde oversees, to ensure house prices don’t rise too fast, he said.
As for investors wondering how to navigate this market, Aalund at Nordea says it all depends on whether they believe the central bank has succeeded in defending the peg or whether it will have to cut rates further.
“A deposit rate of minus 75 basis points? We’ve never had that before,” Aalund said. “If you think it’s going to go away in three months, then it’s not a good idea to buy. But if you think it will prevail, it makes sense to buy.”