Danish Central Bank Moves to Improve Bond Liquidity After Freeze

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Denmark’s central bank took a first step toward mitigating the effect of a freeze on issuance in the government bond market in a move designed to support liquidity.

The bank, which suspended bond auctions in January as part of a set of measures to stop investors hoarding kroner amid a speculative attack on its euro peg, will resume so-called switch operations, it said on Tuesday.

“Switches give market participants the opportunity to exchange existing government securities to new on-the-run securities at market prices,” the bank said. “Switches can contribute to facilitating the trading in government bonds.” The step won’t affect the volume of outstanding bonds “and the decision to suspend the issuance of government bonds remains in effect,” it said.

The central bank has been forced to resort to a series of unconventional steps to defend its three-decades-old currency peg after speculators, emboldened by Switzerland’s decision to abandon its ties to the euro, turned to Denmark. But Governor Lars Rohde prevailed and the government has since announced that anyone betting against the Danish exchange-rate regime lost money.

Tuesday’s decision marks “a step toward normalization,” Jan Stoerup Nielsen, an economist at Nordea Bank AB in Copenhagen, said by phone. “We had expected that the central bank would use this option at some stage, because there’s a problem with liquidity in the bond market.” He estimates the bank could resume bond issuance next quarter. Any increase in its policy rate is “far away,” possibly in the fourth quarter, he said.

Krone Defenses

Defensive measures since January included cutting the benchmark deposit rate to minus 0.75 percent and building currency reserves to the highest level in the country’s history, or about 40 percent of gross domestic product.

Since the end of April, when investors in European bonds started to question the logic of record low, and even negative, bond yields, pressure on the peg has abated and the central bank has been faced with a liquidity squeeze in Denmark’s government bond market.

The yield on Denmark’s 10-year government bond traded at about 0.8 percent on Tuesday compared with a low of 0.1 percent in February.

“The central bank will move very slowly and carefully in normalizing the situation,” Stoerup Nielsen said.

The bank said the timing and choice of bonds to be used in its switch operations will depend on demand. The terms will be announced before conducting the switch operations, it said.

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