Denmark shocked the markets again today and cut its deposit rate even deeper into negative territory. The rate is now -0.5% from -0.35%, which is the lowest ever level. This follows last week’s cut to rates in the wake of the ECB meeting.
The reason for the cut is to maintain the Danish krone’s peg with the EUR. The EURDKK rate had climbed since last week’s ECB decision and subsequent Danish action; however, after reaching its highest level since August on 26th Jan, EURDKK had started to drift lower. The trouble for the Danish authorities is that the DKK is still looking too strong based on the average EURDKK rate of the last few years, and the authorities may need to take further action.
Handelsbanken estimates that the Danish central bank may have had to spend DKK 100 bn defending the EUR peg. Thus, the peg is becoming expensive for the Danish central bank to maintain, and could be under threat.
Below we try to weigh up the reasons for and against dropping the peg:
For:
- Spending DKK 100 bn every time the peg looks shaky is going to get expensive for the Danes, who don’t want to end up in the same position as the SNB.
- How far can they realistically cut the deposit rate without stoking inflation pressure down the line? Although the bank may be happy to cut further in the coming weeks, once you get past -1/-2% things can get tricky from an economic perspective.
- Greece: if the recent Greek election stokes another sovereign crisis then will the Danish people want to join the Eurozone at some stage? Popularity for joining the single currency has been steadily declining in recent years, if the people don’t want to join, then why maintain the peg?
- The dollar: the US Dollar is strengthening on the back of heightened risk aversion, even though the Fed remain cautious on hiking rates, thus, if the US economic data continues to strengthen and the Fed actually bites the bullet and hikes rates later this year then we could see a lot more dollar strength and EUR weakness, forcing Danish intervention to protect its EUR peg.
- The Danish economy is dominated by its service sector with only a small tourist sector, so it could survive a stronger currency.
- Sweden and UK are its second and third largest export partners, and they don’t even use the EUR…
Against:
- The Danish Central Bank’s balance sheet is only approx. 25-30% of Danish GDP. The SNB’s balance sheet was more than 75% of GDP when it abandoned its peg, so there is not an immediate need to make a change.
- It is only hiking rates by incremental amounts, and could continue to make small changes for the next few months without stoking real inflation pressure in the short term.
- The SNB move generated extreme volatility in the market, which the Danish central bank may wish to avoid.
Overall, we think that today’s move highlights that the Danish central bank is not going to give up on its peg anytime soon, and is happy to use the tools available to keep it in place. However, as you can see above, the reasons to disband with the peg are growing, and if Greek fears flare up, or the dollar continues to surge against the EUR, then the Danish authorities could follow the SNB’s lead.
Takeaway: The EURDKK peg lives to see another day, but is still on our watch list, and is at risk of being dropped if it gets 1, prohibitively expensive, 2, EURUSD continues to plunge, 3, rate cuts threaten an inflation surge down the line.
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