Speculators Force Denmark to Adjust Euro-Peg Defense Mechanism

  • Danish central bank says current policy is business as usual
  • Danske, Nordea say response mechanism is now different

Denmark has changed the way it conducts monetary policy in response to a 2015 existential crisis, according to Danske Bank A/S, the country’s biggest lender.

After years of providing a highly predictable set of reactions to currency moves, policy makers in Copenhagen are trying a different approach, Danske Bank senior analyst Jens Naervig Pedersen says. That means speculators intent on testing AAA-rated Denmark’s euro peg in connection with Europe’s election cycle face a rocky ride.

The central bank “wants to keep a bit of unpredictability in the market,” said Naervig Pedersen. “You shouldn’t just expect them always to step in at the same level.” According to Danske and Nordea Bank AB, Scandinavia’s biggest lender, Denmark is intervening in the currency market at different levels than it has in the past, and big interventions aren’t always triggering rate moves, like they used to.

The central bank, in a written response to Bloomberg, said its use of interventions and interest-rate adjustments is “well known.”

“That means that, along with the high level of credibility associated with monetary and currency policy, market participants’ positions typically contribute to stabilizing the krone rate close to the target,” the bank said via a spokesman.

Denmark was forced to explore the extremes of its monetary policy toolbox two years ago, when Switzerland’s decision to resort to a free-floating franc fueled speculation the Danes might follow. The central bank in Copenhagen beat back capital flows by cutting its main rate to minus 0.75 percent, hoarding record foreign reserves and cutting off the supply of government bonds. It prevailed back then, but the krone is again testing the same strong levels it reached in early 2015.

The central bank targets an exchange rate of 7.46038 per euro within a 2.25 percent band. In practice, it has acted much earlier to defend the peg. It has also tended to signal to the market that a rate move was to be expected once interventions reached a certain size. That pattern has now been broken, Naervig Pedersen says.

Keep It Moving

February’s reserve data is a case in point. The central bank sold 4.7 billion kroner ($668 million) to weaken the currency as political risk across Europe drives investors into safe-haven markets such as Denmark’s.

“Last month’s interventions would normally have gotten people out of their seats because it would have been enough to get them thinking a rate cut might be coming,” Naervig Pedersen said. “But that’s not likely to happen given the current rate level.”

Jan Storup Nielsen, a senior analyst at Nordea in Copenhagen, estimates the central bank won’t tolerate any krone appreciation beyond 7.4320 against the euro. In December, Nielsen put the bank’s previous red line at 7.4350. Danske says its analysis suggests the central bank will dump kroner on the market once the exchange rate strengthens beyond 7.4330 to the euro. The krone traded at 7.4335 on Wednesday.

“The central bank will keep the target moving while keeping it to themselves where it is,” Storup Nielsen said.

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