ECB Agenda Tests Central Bank Extremes in Denmark: Nordic Credit

Today’s rate cut from the European Central Bank is testing the limits of Denmark’s monetary policy tool box.

The central bank in Copenhagen, which uses rates to defend the krone’s peg to the euro, cut its key lending rate by 10 basis points to 0.20 percent as the benchmark again closes in on zero. That compares with a 25 basis-point cut by the ECB, which the bank typically follows. It left the deposit rate at minus 0.1 percent.

The bank said it had “limited leeway” to reduce the lending rate. Danish policy makers have resorted to unprecedented easing to prevent the krone strengthening beyond the limits of its peg.

Fiscal restraint has left Denmark a haven from the debt crisis in southern Europe, driving down the Nordic nation’s bond yields. Banks have paid to deposit money with the central bank since July, when the bank first cut the rate below zero to find off the capital influx into its AAA markets.

“The central bank has been very clear about stating that the lending rate won’t be negative or zero,” Jan Stoerup Nielsen, senior analyst at Nordea Bank AB, said in an note. The smaller cut allows the bank “to keep some ammunition if the ECB at a later point cuts its rate further.”

Relative Yields

The low rates have taken their toll on Denmark’s financial industry. Danske Bank said today net interest income dropped 3.5 percent last quarter from a year earlier. Even an increase in market share and the “positive effect” of pricing failed to offset the impact of lower interest rates, Danske Bank said.

“We are gradually financially putting the crisis behind us,” Chief Financial Officer Henrik Ramlau-Hansen said today in an interview. “But we are also suffering from the very low level of interest rates, which are hitting our deposit margins.”

The yield on Denmark’s 1.5 percent bond due November 2023 traded at 1.2904 percent, leaving its spread relative to similar-maturity German bunds at 11 basis points. Two-year Danish debt yielded 0.062 percent. Denmark has lower 10-year borrowing costs than any euro member, after Germany.

“The room to maneuver isn’t as big for Denmark, so the Danish central bank has to be more careful in following the ECB,” Klaus Rasmussen, chief economist at the Confederation of Danish Industry, said in an interview before the rate cut. “A lending rate of zero would be hard to believe. It has to be a little bit over zero.”

Currency Reserves

The krone traded as strong as 7.4553 against the euro yesterday, versus the central bank’s targeted rate of 7.46038. The Danish currency was as strong as 7.4306 per euro in May last year and as weak as 7.4633 in January. Foreign currency reserves reached a high of 514.4 billion kroner ($91 billion) in August and have since declined to 491.7 billion kroner in April, the central bank said today.

The low rates left analysts divided over what the central bank would do.

“We are in unknown territory,” Niels Roenholt, a senior economist at Jyske Bank, said in a phone interview before the announcement. “This time around it’s a little tricky.”

Jyske said there was a chance the central bank may do nothing rather than risk using up all its ammunition, while Danske Bank A/S said a 15 basis point cut was also possible. Jacob Graven at Sydbank A/S said Danish policy makers could decide not to cut either the deposit or lending rate. Such a step would be “quite unusual” given the bank’s history of following the ECB, he said.

Overnight Accounts

The bank doesn’t hold scheduled meetings and only adjusts rates to defend the currency peg. It last raised rates in January by 10 basis points after signs of improvement in the euro area triggered a sell-off of haven assets. To counter the impact of its negative deposit rate on the financial industry, the central bank has raised the cap on overnight accounts, which offer a zero interest rate.

Though the central bank’s policy mandate doesn’t give it scope to respond to demand in the economy, the nation’s haven status has resulted in record low borrowing costs that are underpinning consumer demand.

The government of Prime Minister Helle Thorning-Schmidt has rejected calls to increase stimulus measures, arguing instead budget discipline will support Denmark’s haven status, keep borrowing costs low and deliver indirect monetary support to the economy.

“We will not leave a mountain of debt for coming generations,” Economy Minister Margrethe Vestager said this week.

Mortgage Effect

Denmark’s record-low rates have carried over to the nation’s $550 billion bond-backed mortgage system -- the world’s biggest on a per capita basis. The yield on the Nykredit 2 percent mortgage note due April 2014 eased to 0.29 percent yesterday, from 0.84 percent a year earlier, according to data compiled by Bloomberg.

That’s helped the world’s most indebted households survive a slump of more than 20 percent in property prices since their 2007 peak. Danes’ personal debt is 267.31 percent of income, according to Eurostat data compiled by Bloomberg. By comparison, Sweden’s ratio is 148.77, the Netherlands is 250.45, and the U.S. is 93.87 percent.

Central bank Governor Lars Rohde said last month policy makers seeking to fuel growth have pumped the financial system with so much liquidity that an exit risks stunting a recovery and bursting potential asset bubbles.

Crisis Support

For now, most indicators suggest the euro area still needs crisis support measures. Euro-area unemployment hit 12.1 percent in March, its highest on record. Denmark’s government this week cut its economic growth forecast to 0.7 percent, while economists at Danske Bank and Svenska Handelsbanken AB both estimate Denmark probably slipped into a recession last quarter.

Monetary easing “will give a positive impulse to growth all over Europe,” Rasmussen at the Confederation of Danish Industry said. “It will feed into consumption, and it will also help businesses.”

The Danish central bank has signaled reluctance to venture further into negative rate territory.

“With low monetary policy interest rates, the room for further reduction of Denmark’s Nationalbank’s lending rate is limited,” the bank said in a website posting dated April 10. “The lending rate will remain positive.”

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