Will Denmark Throw in the Towel on the Peg?
The Swiss National Bank shocked markets last month by abandoning its cap on the value of the Swiss franc against a plunging euro. Since then, speculation has been rife in markets that Denmark’s central bank could be the next to throw in the towel.
With almost alarming regularity, the Nationalbanken, Denmark’s central bank, has lowered interest rates four times already this year to limit the krone’s appeal and defend its peg—which is intended to provide a stable backdrop for Danish companies.
The peg seeks to stop the euro falling more than 2.25% below (or rising 2.25% above—although that’s not the issue right now) 7.46038 krone, by buying (or selling) foreign currency. The bank’s also stepped up its intervention in currency markets and even suspended issuance of government bonds in a bid to lower the krone.
But all the rate cutting has fueled talk that the Danish central bank is starting to think twice about the huge quantities of foreign assets it needs to buy to defend the peg.
Jens Nordvig, head of fixed income research at Nomura, notes that so far this year the Nationalbanken has increased its reserves by more than $30 billion as it buys foreign currency to hold down the krone. That means in terms of the size of its economy, Denmark is intervening at a similar pace to that of Switzerland right before the Swiss bank decided to remove the limit on the exchange rate between the franc and the euro.
“There is no doubt that the pressure on the krone is very significant, and that the fight for the peg will be a tough one,” Nordvig said.
But investors shouldn’t get carried away with the Swiss-Danish parallels. That’s because the background to Denmark’s peg is very different, according to Mr. Nordvig.
Unlike the Swiss currency cap, a recent innovation introduced in 2011 to deal with the franc’s strength during the euro crisis, the Danish peg has been around since 1982 (when the currency was pegged to the Deutschmark). And the Danish peg has widespread political support and the backing of all major political parties. There’s no sign of the popular opposition to monetary policy that led to a Swiss referendum late last year aiming to force the central bank to hold more gold.
As long as the political will remains, analysts reckon the Nationalbanken has the tools at its disposal to defend the peg. A central bank trying to prop up its currency by selling reserves (like Russia recently) can run out of assets to sell. But buying assets to weaken your currency is, at least theoretically, a limitless exercise.
“Even if a central bank turns insolvent for a while, IT IS A CENTRAL BANK. They don’t care about liquidity, and can survive technical insolvency [in the] worst case,” said Aurelija Augulyte, a senior currency strategist at Nordea.
