Denmark has surprised many today by abandoning its two-year-old experiment in negative deposit rates. Today it hiked its key rate to 5 bp from -10 bp. It has had negative rates since July 2012.
Part of the reason it is a surprise is that the ECB itself has been touting the possibility that it could adopt negative interest rates or launch an asset purchase plan. Denmark, which decided not to join the monetary union, keeps its currency tightly tied to the euro.
This is the main anchor of its policy. In effect, it has pegged to the euro and therefore has surrendered its monetary policy autonomy, without some of the benefits of being in EMU itself, such as access to the ECB and ESM. It also preserves some fiscal autonomy, albeit quite limited.
Today's move is not a tell of ECB policy. Rather, the Danish central bank is sticking to its knitting, keeping the krone pegged to the euro. Within the narrow ranges that the krone moves against the euro, it has been weakening this year.
Partly this is a function of resilience of the euro, due, it appears, to a large current account surplus and portfolio, direct and speculative investment inflows. Partly, as we have noted, EONIA has been creeping up and the short-term interest rate spread weighed on the krone. The rate adjustment has seen the krone bounce back and is at its best levels in a month against the euro.
In order to defend its peg, the Danish central bank appears to have been intervening. Its reserves have fallen by about DKK15 bln in Q1 after falling by about DKK30 bln in all of last year. This may understate the decline in reserves as assuming some yield and capital appreciation of the assets held in reserves would suggest a modest increase.
Reports suggest Danish banks never passed the negative deposit rate to clients, but several foreign banks did. The negative deposit rate also pushed many short-term interest rates negative. Some observers do suspect that this reduced the incentive for household savings and household indebtedness was estimated last year at over 3x disposable income.
In some ways, the weakness of the krone is also a reflection of the reduced risk to the EMU project. Recall that the condition that had strengthened the krone previously and led to the negative deposit rate was the use of the krone as a AAA safe haven. This is also what we suspect is behind some of the flows into the peripheral bond markets. Yes, it is a chase for yield, really risk-adjusted returns. The risks of inflation and redenomination have fallen sharply, even though debt levels (except for Germany) are higher.
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