Market Economics | Interest Rate Strategy - BNP PARIBAS ...

Denmark: The Tide is Turning
• Given excess liquidity in the eurozone,
higher money market rates in Denmark led to an
appreciation of the krone earlier in 2010.
Chart 1: 3m Interbank & Official Rate Spreads
• The krone, however, has been depreciating
vis-à-vis the euro in recent weeks.
• This seems to be driven by lower excess
liquidity in the eurozone and thus higher money
market rates.
• Given these recent developments, we no
longer expect rate cuts from the central bank.
• There is some evidence that the Danish
central bank already started to draw on its FX
reserves to defend the currency.
• We expect it to continue to do so as long as
the weakening trend continues. Only if this
proves unsuccessful and reserves fall too
much, policy rates would be raised.
Lower rates so far this year…
Since the beginning of this year, the Danish central
bank has cut its policy rate by a total of 15bp to
1.05%. The interest rate on certificates of deposit has
been cut even more, by 45bp to 0.5%. These
reductions were a “consequence of further purchases
of foreign exchange in the market”. The
strengthening of the currency was a tightening of
monetary conditions, with the accumulation of
reserves an attempt to prevent this. But continued
appreciation pressures had to be reflected in an
easing in another aspect of monetary conditions,
namely official interest rates.
As we have highlighted before (see Denmark:
Surprise, Surprise, Market Mover, 15 January 2010),
as there is excess liquidity in the eurozone, the rate
determining eurozone market rates is the deposit
rate (0.25%) rather than the ECB’s refi rate (1%). On
the other hand, the Danish central bank does not
leave excess liquidity in the banking system. Instead,
it supplies the liquidity banks want (full allotment) but
then mops up with certificates of deposit (now at
0.5%). This certificates of deposit/deposit rate
differential, which explains higher money market
rates in Denmark compared to the eurozone (Chart
1), led to hot-money inflows. This in turn
strengthened the Danish krone vis-à-vis the euro and
prompted the Danish central bank to cut rates.
…as the DKK gained ground
The last two deposit rate cuts from the Danish central
Source: Reuters EcoWin Pro
Source: Reuters EcoWin Pro
Chart 2: EUR/DKK
bank (in May) were also driven by these factors.
Given the intensification of stress in financial markets
due to fiscal jitters in the eurozone, the ECB
announced measures to enhance liquidity in the
system. This also had implications for Denmark. For
example, a eurozone bank with excess liquidity could
put the money in Denmark at 0.7% (before the two
rate cuts in May) rather than getting 0.25% in the
eurozone.
These rate differentials in turn led to an appreciation
of the krone vis-à-vis the euro. In mid-June,
EUR/DKK reached its lowest level since the
beginning of 2005.
But recently EUR/DKK has been moving higher
very quickly…
Since mid-June, however, EUR/DKK has been
trending higher (Chart 2). On 13 July, EUR/DKK
reached its highest level since October 2008, a
period when the Danish central bank was increasing
rates to bolster the krone.
Gizem Kara 16 July 2010
Market Mover
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