The Danish krone (DKK) has been highly volatile lately. It started the month under pressure and we have rea-son to believe that it was the Danish central bank's in-terventions in the foreign exchange market that pre-vented EUR/DKK from drifting too far from central par-ity. The reason behind the pressure was that Euroland deposit rates had drifted substantially higher than Danish deposit rates, ie, EUR/DKK enjoyed a positive carry. The Danish central bank surprised markets late Tuesday by raising the lending rate from 4.60% to 5.00%. Even though this did not spark a rush into DKK, it helped curb EUR/DKK's upward drift. The ECB de-cided to lower its benchmark rate from 4.25% to 3.75% in a coordinated action with other central banks on Wednesday, but the Danish central bank announced a little later that rates would remain unchanged "for the time being". EUR/DKK dropped immediately by close to 100bp and has since drifted even lower, at present trading around 7.45.
In our view, the policy spread between Denmark and Euroland will eventually be narrowed. Having spent some of the currency reserve in interventions to sup-port DKK, the Danish central bank might prefer to maintain a substantial spread to Euroland in the short run. This could also help to rebuild the currency re-serve if the central bank starts to buy foreign currency against DKK. However, we doubt that Danish rates need to exceed Euroland rates by the current 125bp for a prolonged period. Changes in the ECB's tender procedure and in the standing facilities corridor an-nounced Thursday will also act to support a narrowing of the official spread between Denmark and the ECB, as it will lower Euroland money market rates.
