- After the SNB dropped the EUR/CHF floor last week, focus has turned to the EUR/DKK peg
- We expect the EUR/DKK peg to remain in place…
- …because it is part of a long-term policy and because FX reserves are not at unsustainable levels
- The central bank will probably step up FX intervention and cut interest rates to defend the peg
Pressure on the central bank to abandon its peg
Since the surprise announcement by the Swiss National Bank that is was discontinuing the floor in EUR/CHF, expectations in financial markets have built that the Danish central bank would follow the same road and abandon the peg in EUR/DKK. As a reaction, the central bank of Denmark lowered its lending rate and interest rate on certificates of deposit by 15 basis points to 0.05% and -0.2% respectively. The discount rate was left unchanged at zero. It also stated that it has tools left to fend off krone appreciation, including using the de facto fluctuation band, FX intervention and rate cuts as well as liquidity-adjusting operations.
Policy of permanent anchoring…
If we take a step back from recent developments we conclude that the situation is completely different for the Danish central bank than for the Swiss National Bank. Therefore, we judge that the abandoning of the peg is unlikely. For starters, since the 1980s Denmark has had its exchange rate anchored to the Deutschmark/euro, as it judged that the resulting stability would have positive effects on inflation and growth. The eurozone is its largest trading partner. For example 38% of its exports are destined to the eurozone. As Denmark is part of ERM2 (see box) the ECB is also committed to protecting the peg.
Although Switzerland has a similar trade exposure to the eurozone, it decided to have a freely floating currency. The decision for the floor in EUR/CHF was not driven by the motivation to have the Swiss franc permanently anchored to the euro. The SNB placed a temporary the floor in EUR/CHF to avoid a sharp strengthening of the Swiss franc, which was already very strong. In the case of Denmark, the krone is not extremely overvalued (see graph below).
…FX reserves not at unsustainable levels…
What is more, FX interventions by the central bank of Denmark have not resulted in an unsustainable level of FX reserves compared to GDP. FX reserves as percentage to GDP are only 25% while those of the SNB are close to 75% of GDP.
This is because financial markets have accepted the EUR/DKK peg as given. Moreover, the krone has in general no safe-haven characteristics and the financial industry of Denmark cannot be compared with that of Switzerland. Switzerland is well known for its private banking, hedge fund and commodity sectors.
…and monetary policy that is linked to that of the ECB
The main objective for Danmarks Nationalbank is to ensure stable prices, i.e. low inflation (below but close to 2%, similar to the target of the ECB). This is achieved through the monetary and exchange rate policy.
Its policy is aimed at keeping the krone stable against the euro. Usually it changes its interest rates in sync with monetary policy rates of the ECB. With the upcoming QE program of the ECB, the central bank has started to intervene in currency markets again. In addition, it is likely that it will cut interest rates below that of the ECB because of the absence of QE in Denmark (apart from FX intervention) and inflation being far away from its target.