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Denmark Cuts Deposit Rate Third Time this Month to Defend Kroner Peg

Posted by Joseph Trevisani on Jan 29, 2015 12:33:00 PM

The Danish central bank reduced its main interest rate for the third time in 10 days in an effort to defend the country's peg of the krone to the euro.

The Danmarks Nationalbank dropped its certificate of deposit rate 15 basis pointsto -0.5 percent effective tomorrow. It had previously cut the rate to -0.2 percent from -0.05 percent on the 21st and to -0.35 percent on the 23rd.  The lending rate was unchanged at 0.05 percent. 

The central bank is struggling to prevent the Danish Krone from appreciating against the euro as currency traders buy the krone against the euro speculating that the bank may have to abandon its peg, as the Swiss National Bank did two weeks ago with the franc. The Danish Krone is freely traded but maintained within a narrow trading band by the central bank. 

Svenska Handelbanken AB estimated the central bank may have sold as much as 100 billion kroner (15.8 billion euros) in the past month to defend the currency peg, according to Bloomberg. 

"It is difficult to put a label on where the flows are coming from. It is both domestic and foreign," said Karsten Biltoft, the head of communications for the bank, in a phone interview with Bloomberg. "There are two instruments in the toolbox, interventions and rate changes, and those instruments remain in the toolbox to be used." 

The Danish central bank may face the same problems that doomed the Swiss National Bank's (SNB) effort to prevent franc appreciation.

In order to defend the peg the Danish central bank buys euro and sells kroner in the  currency market, accumulating in the process a large fund of devaluing euro, distorting the bank's balance sheet.

In the case of the SNB euro reserves bought in defense of the 1.20 euro peg may have reached 75 percent of GDP. The SNB also reduced its interest rate to -0.75 from -0.25 percent on January in an ultimately futile attempt to prevent the end of the peg. 

The ECB sovereign debt purchase plan has put enormous pressure on the krone-euro link by effectively devaluing the common currency. The euro has fallen almost 20 percent against the dollar since May.

The krone has been pegged at 7.46038 to the euro for fifteen years since the euro started commercial trading on January 1st 1999 as part of the European Rate Mechanism. The official 2.25 percent trading band, 7.29252 to 7.62864, has in practice been much narrower, less than 1 percent. 

Though the Maastricht Treaty of 1992 which set up the euro and the European Central Bank requires that EU members join the common currency Denmark negotiated an exception, which is subsequently took.  Denmark held a referendum in September 2000 on membership in the common currency. With 87.6 percent of eligible voters casing ballots, 53.2 percent voted no and 46.8 percent favored joining the euro. 

In defending its euro peg the Danish Central Bank, may have a powerful, if perhaps unofficial, ally. The ECB might not wish to see the disruptive effect of its policies made so evident with the world looking on.   

The Danish krone was trading at 7.4421 against the euro at 12.36 pm in New York. That compares with 7.4475 at the beginning of the year.

 

Joseph Trevisani

Chief Market Strategist

WorldWideMarkets Online Trading

Charts: Bloomberg

denmark rate jan 29

krone jan 29

 

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