Aktuel analyse fra BNP Paribas:
Market estimates suggest that the Danish central bank’s currency intervention has increased as much as fourfold in February, indicating that the peg remains under pressure. The costs of intervention will increase over time. Pension-fund liabilities will be more difficult to meet, a bubble in the housing market more likely and the path of inflation less certain. Intervention will continue and we also think the deposit rate will go to -100bp. That it has not done so already shows the central bank is becoming more wary of the costs involved. We do not think Denmark’s currency peg is at breaking point, but market estimates of intervention by the central bank show that following a month of record intervention totalling DKK 106bn in January, pressure has continued to build. Estimates for early February suggest that intervention may now be running at DKK 100bn per week, meaning flows have increased by a factor of four relative to January. If this rate is maintained throughout the month, Danish foreign reserves will have doubled from DKK 446bn at end December to almost DKK 1trn by end February.
The obvious question is how long can this go on? On the face of it, quite a while. The central bank could continue to intervene indefinitely, in theory, as it can create domestic currency in limitless supply and use this to purchases euro assets. However, the Swiss National Bank’s (SNB) decision to abandon its peg has opened a Pandora’s box of currency risk that the Danish central bank is struggling to contain. The SNB dropped its peg as it was staring down the barrel at a vast quantum of euro sovereign bond purchases by the ECB. The problem for the Danish central bank is that ECB quantitative easing (QE) has not yet begun and historical experience of QE in other jurisdictions shows that flows matter when it comes to currency valuation. This raises the prospect of the Danish central bank remaining under pressure for a prolonged period. The DKK peg to the EUR enjoys almost religious status in Denmark.
There is huge political buyin and the central bank’s sole mandate is to uphold it. Still, its sustainability ultimately depends on the costs and the benefits of its preservation. Its benefit is that it is widely perceived to have underpinned three decades of economic prosperity and stability. The competitiveness benefits of the peg have turned a persistent current account deficit into a persistent surplus (Chart 2). What’s more, exports have increased from about 35% of GDP to 55% over the past 30 years. Whether similar benefits can be attained over the next 30 is questionable. Until the current episode, Denmark had attained a high level of stability and was one of the few sovereigns to retain an AAA rating. Thus, it may be that it does not need to be shielded from FX volatility as a more mature state. The experiences of Sweden and Norway, both of which weathered the financial crisis relatively well in GDP terms, albeit with the help of oil wealth in the case of Norway, suggest that a free-floating currency need not be a hindrance to growth. And now, the calculus of preserving the peg is changing, with the cost increasing by the day as FX intervention mounts.
The costs of the peg are likely to manifest themselves in three different areas. They will hurt the sustainability and profitability of the domestic financial-services industry, lead to a greater chance of asset bubbles and cause a vast expansion of the monetary base, putting upward pressure on inflation. As long as the viability of the peg is in doubt, the demand for Danish assets will depress their yields, creating problems for pension funds and originators of domestic mortgage bonds. The yield on Danish government bonds is already negative out to the eight-year maturity and the central bank deposit rate is -0.75%. The longer this persists, the greater the problems domestic institutional investors will have in terms of meeting future liabilities. Prior to the collapse of the Swiss peg, the Danish currency was stable and the price of currency risk versus the euro was effectively zero. However, as that currency risk against the euro has now re-emerged, the substantial cost of this risk to the financial-services industry and the wider economy is being borne by the central bank. The cost of bearing this risk is rising daily.
Extremely low policy rates for a sustained period also increase the chance of a house-price boom. House prices are recovering following a slump in 2009 and are now growing close to 4% annually. The Danish mortgage market is one of the most advanced in the world, with mortgage banks effectively acting as intermediaries between investors in Danish mortgage bonds, which finance the system, and mortgage borrowers. It is the yield on these bonds, rather than the banks, which sets the interest rate on mortgages, meaning the price of mortgage debt is closely linked to the market. While fixed rates are common, there are no penalties for early repayment. To refinance, a borrower must effectively purchase mortgage bonds on the market equivalent to the mortgage debt and deliver them to the lender. This means that if the current wave of low yields on mortgage bonds persists, there is likely to be an increase in borrowers looking to remortgage at lower interest rates, which will simply reinforce current market dynamics. Extremely low rates for new borrowers and the ease of refinancing for existing borrowers means that house prices run the risk of becoming inflated. Indeed, data for Q4 2014 already show a spike in gross mortgage lending, adding fuel to the fire.
The rapid expansion of the monetary base as the central bank continues to print currency may ultimately lead to unwanted inflationary pressure. The link between narrow money growth and inflation is imprecise, but history shows that very high inflation is nearly always preceded by speedy expansion of the monetary base. Admittedly, with CPI inflation at -0.1% y/y in January, this does not seem like a pressing concern, but the central bank will have less and less certainty over its forecast path of inflation the longer the intervention continues. The size of the central bank’s balance sheet provides a rough estimate of the cost of preserving the peg, simply because the scale of intervention reflects the size of the opposing flows. The central bank will have its own view of how long these flows will continue. The longer these flows persist, however, the greater the chance the bank will need to reassess its estimates of the cost involved. If these costs continue to mount, there has to come a point of inflection when the bank judges the cost of the peg to outweigh the benefit. We are not at that point yet and intervention will continue. Another cut in the deposit rate remains probable, in our view, but the bank’s failure to enact such a cut in the last week shows that the price of defending the peg is increasingly weighing on the Danish central bank.
