Denmark has temporarily stopped selling new bonds to investors, it said on Friday, shocking a currency market still reeling from the Swiss central bank's decision to stop limiting the franc's value against the euro. But while unexpected and unconventional, the Danish move underscores a commitment to its decades-long fixed currency policy and is aimed at weakening the crown to keep it within a tight range to the euro.
Pressure had been building on the crown since the Swiss National Bank abandoned its cap on January 15, letting the franc surge against the euro, and the European Central Bank adopted a bond-buying scheme that helped weaken the euro more broadly. Denmark's central bank had already cut its deposit rate three times in the past two weeks deeper into negative territory at -0.5 percent, effectively charging investors for parking their money. But other official rates and bond rates remained positive, spurring demand for crown-denominated assets.
The central bank now hopes that removing the option of buying new Danish government bonds will reduce demand for the crown while pushing investors towards existing longer-dated bonds, which would lower borrowing costs more broadly. The government had been due to issue 75 billion Danish crowns ($11 billion) worth of domestic debt to cover its 2015 financing needs. It tends not to issue foreign-denominated debt.
"They have been successful with pushing the short rates down but not the longer rates and that has been the catalyst for continued inflow into the Danish asset market," Kamal Sharma, G10 FX Strategy Director at Bank of America Merrill Lynch, told Reuters. "They are obviously looking at the full extent of the policy tool kit." Denmark voted against following its neighbours into the euro zone but, under the European Union's Exchange Rate Mechanism (ERM2), it agreed to keep the crown at 2.25 percent either side of the parity rate of 7.46038 crowns to the euro. In practice, the crown has not moved more than 0.5 percent on either side.
The policy has wide backing across the political and corporate spectrum. Analysts said the central bank had a host of tools before it would consider dropping the peg, but most thought it would cut rates further and possibly widen its tight corridor. "We had not expected this," said Jes Asmussen, Chief Economist at Handelsbanken. "Everything that happens now is surprising. We had expected the central bank to start to use other instruments if the pressure on the crown continued, but we did not consider it would be this exactly."
Nordea's senior analyst, Jan Storup Nielsen, compared the move to quantitative easing (QE), referring to the ECB's bond-buying programme. Analysts had said Sweden could be next to follow suit, but not Denmark. "This is basically QE through the back door," Nielsen said. "Instead of increasing demand they reduce supply and a result of that is lower interest rates."
The central bank has previously said it had intervened in the foreign exchange market. It has not specified by how much but some analysts have said it may have spent as much as 100 million Danish crowns, boosting reserves. "Denmark's National bank expects that stopping the issuance of government bonds will contribute to reducing the interest-rate spreads in the longer maturity segments and thereby limit the inflow of foreign exchange," it said in a statement. Higher reserves have "resulted in a widening of the negative spread between money market rates in Denmark and the euro area.
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