ECB Brings Negative Rate Abyss to Denmark Girding for Next Round

There is no limit.

For Denmark, where the sole monetary policy mandate is to defend the krone’s peg to the euro, the central bank is reminding markets that it has limitless scope to deter another speculative attack on its currency regime.

QuickTake Negative Interest Rates

“We are quite confident that we would be able to handle a new wave, if some central banks around the world go even lower,” Governor Lars Rohde told Bloomberg in an interview in Shanghai. “We have a lot of instruments in our toolkit and we will use them.”

Rohde even acknowledges that market predictions pointing to negative Danish rates for most of the rest of this decade might well come true.

Here’s a reminder of what the Danes went through a little over a year ago:

  • The Jan. 15, 2015, decision by the Swiss to abandon their cap on the franc emboldened speculators to make AAA-rated Denmark their next target.
  • The Danes responded with a swift series of rate cuts, bringing the benchmark deposit rate to minus 0.75%, raising currency reserves to about 40 percent of GDP and suspending government bond sales.
  • By March, speculative pressure had abated and the central bank was able to start planning a path toward monetary policy normalization. It raised its deposit rate by 10 basis points in January. (See this, this and this for more background.)

But Denmark is small, and the best-laid plans can be upended by events outside its borders.

Danske Bank, Denmark’s biggest lender, says Rohde’s next step will be to cut the benchmark deposit rate back down to minus 0.75 percent on March 10. (That will follow a 10 basis point cut by the European Central Bank earlier the same day, Danske predicts.)

“Monetary conditions in the euro area are gradually converging toward monetary conditions in Denmark, which in our view is EURDKK negative,” says Jens Naervig Pedersen, a senior analyst at Danske Bank.

The Copenhagen-based bank is telling the pension funds it advises to build their hedges to protect against a sudden krone appreciation against the euro as flows into Denmark’s AAA-rated assets are seen picking up.

Yields on shorter-dated Danish government debt traded lower on Thursday. The yield on the two-year note was down about five basis points at minus 0.3 percent as of 10 a.m. in Copenhagen.

But betting against the Danish central bank is a risky undertaking. Rohde, who won praise from the International Monetary Fund last year for his ability to beat back speculators, says investors trying to undermine the krone’s peg to the euro made several mistakes.

“They underestimated how well-rooted the policy is in Denmark,” he said. “And they also underestimated another factor: if the pressure on the currency is for appreciation, one should be aware if you are trying to speculate against us, that we have unlimited access to Danish kroner. We can expand the balance sheet without limit” even if “you can’t cut interest rates without limit.”

Most economists tracking Denmark predict monetary policy won’t go positive until 2018 at the earliest, a base-case scenario that Rohde says is possible. Given that Danish rates first fell below zero in mid-2012, the country will have been in negative territory for the better part of six years, if the forecasts hold.

The upshot is that negative rates don’t behave that differently from positive rates, according to Rohde.

“Basically the system is working the way we expected,” he said. “Basically, it’s not different from having a low positive interest rate.”

Before it's here, it's on the Bloomberg Terminal.