Central Bank in Denmark Loses Tool After Debt Funding Need Jumps

  • Government's cash reserve risks becoming too low, Nordea says
  • Debt office may be forced to raise 2015-2016 auction target

Denmark’s revelation it will need to borrow at least 6 percent more from bond markets next year is putting unwelcome pressure on its exchange rate regime.

Nordea, Scandinavia’s biggest bank, says the development means the central bank has lost its freedom to switch off bond auctions should Denmark’s euro peg come under attack, as it did in January. The nation’s borrowing need is now simply too big for that option still to be on the table, according to Nordea.

“If there were to be another attack on the krone, the Danish central bank
won’t be able to use this tool with government reserves this low,” Jan Størup Nielsen, a chief analyst at Nordea Markets in Copenhagen, said by phone on Tuesday.

Well after markets had closed on Monday night, AAA-rated Denmark’s government revealed it will need to borrow 153 billion in kroner ($23.5 billion) next year, 6.3 percent more than estimated in August. This year’s borrowing need was revised up by 4.8 percent, to 132 billion kroner.

Denmark's 10-Year Bond Yield
Denmark's 10-Year Bond Yield

The Danish government on Tuesday presented a 2016 budget that included more spending on health care and a shortfall that was larger than previously estimated. 

“Bigger deficits won’t be funded by higher taxes,” Finance Minister Claus Hjort Frederiksen told Bloomberg. “So that only leaves the options of issuing more bonds or cutting costs.”

The government will rely more on bond markets eight months after suspending all issuance as part of a package of measures designed to keep investors away. The decision followed Switzerland’s January shock move to send its franc into a free float, prompting conjecture that Denmark might do the same.

But unlike Switzerland, Denmark was able to beat back speculators and defend its three-decades-old currency peg. It cut its main rate to minus 0.75 percent, built up reserves until they accounted for 40 percent of gross domestic product and switched off bond issuance.

Last month, the central bank said conditions had normalized to a degree so as to allow it to resume bond auctions. The first sale is scheduled for Oct. 7. No target will be set for individual auctions but the debt office -- a department inside the central bank -- says it plans to issue 100 billion kroner through 2016.

That won’t be anywhere near enough, now that the borrowing need has been raised, Nielsen said. It would leave the government with just 50 billion kroner at the end of next year, compared with a buffer of about 200 billion kroner in recent years, he said.

“The Danish government is at risk of having very little in reserves by the end of 2016,” Nielsen said. “The buffer will be too small. It would be risky because the government could run out of cash if an unexpected crisis should happen that effects bond sales.”

Nielsen estimates the debt office will raise its bond issuance target by about 25 billion kroner early next year to help improve the buffer. The pricing, however, may not be as good as Denmark has been used to.

“Denmark will have to issue a lot of bonds in the near future and all things equal this means that the spreads to the euro zone will widen,” he said. “Denmark will be issuing more bonds at a time when there will be a big buyer of euro-zone bonds in form of the ECB, whereas Danish bonds may not attract the same level of interest.”

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