Currency War Plagues Denmark as Central Bankers Run Out of Tools

  • Krone as strong as during Jan. 2015 speculative attack on peg
  • Danske Bank sees little scope for central bank to cut rates

Denmark’s krone is now trading at levels not seen since the run-up to the country’s worst currency crisis this century.

On Jan. 15, 2015, currency speculators attacked Switzerland, then Denmark. Switzerland famously resorted to a free float. Denmark, perhaps less famously, prevailed after throwing everything it had at those betting against the krone’s peg to the euro.

While some of those measures have since been unwound, the upshot is that the Danish central bank has considerably less scope now to fend off an attack than it did at the beginning of 2015, according to Jens Naervig Pedersen, a senior analyst at Danske Bank A/S. 

The krone has strengthened since the ECB cut in March and Denmark didn’t follow. The krone is pegged to the euro.

At the beginning of last year, Denmark’s starting point was a benchmark deposit rate at minus 0.05 percent. Now, it’s minus 0.65 percent. In January 2015, Denmark had yet to switch off government bond sales. Now, investors have made clear they won’t take kindly to any new liquidity-sapping measures, making such a policy step considerably riskier.

Danske, Denmark’s biggest lender, says the central bank only has about 10 basis points in rate cuts left in its tool box.

“Denmark’s lower bound remains at minus 0.75 percent -- we really don’t think it will go lower,” Pedersen said by phone. “It would require another central bank to show that it’s feasible to go below minus 0.75 percent if the Danish central bank were to go lower than that.”

A suspension of government bond auctions, which Denmark enforced for eight months of 2015 to stop investors hoarding AAA krone assets, is now also off the table, according to Jan Stoerup Nielsen, a senior analyst at Nordea Bank AB.

“I don’t consider that an option,” Nielsen said by phone. “It would challenge their credibility and the bank’s pledge to keep substantial bond liquidity. Besides they actually need the money to fund government deficits now.”

The Danish central bank raised its benchmark deposit rate by 10 basis points to minus 0.65 percent in January as Rohde has tried to normalize policy. Denmark has had negative rates for the better part of almost four years, with most economists predicting rates won’t go positive until at least 2018.

But speculators shouldn’t draw too much comfort from all this. There is one key tool the central bank can still use and that’s currency interventions. According to Danske’s Pedersen, it’s probably the most potent policy response Denmark can deploy.

Denmark managed to bring FX reserves back to pre-crisis levels, giving it room to sell DKK quickly should it need to.

“The lesson from last year’s krone-crisis is that the most effective tool employed by the central bank was when Governor Lars Rohde reminded the market he could print as much money as he wanted to,” Pedersen said.

The central bank is “ready whenever” the need should arise to do so again, Rohde said last week in an interview with Bloomberg.

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