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Danish Central Bank hikes rates

Wed, Oct 8 2008, 08:04 GMT
by Steen Bocian, John Hydeskov

Danske Bank A/S

Danmarks Nationalbank (DN) decided earlier today (7 October) (17.00CET) to raise its lending rate from 4.60% to 5.00%. The discount rate and the interest rate on the banks' current accounts with DN are raised by 0.25% to 4.50%. All interest rate increases are effective from 8 October 2008. Both the decision to hike rates, the magnitude by which rates have been hiked and the timing of the rate hike will surprise markets, although the likelihood that the bank would hike has increased in recent days.

In the following statement, DN cited the reduction of the spread between DN's lending rate and ECB's marginal rate as the main reason behind the rate hike. The central bank said that the interest rate spread has recently been negative, resulting in an FX outflow. It noted further that it had intervened in the FX market to support DKK and said that the intervention had reached a stage which resulted in the increase in the lending rate. In the opinion of DN the size of the rate change reflects the need to re-establish a positive rate spread.

In Factors affecting DKK published on Monday we argued that "Money market tensions will, in our view, be the dominant driver for EUR/DKK in the coming months. As long as EUR/DKK enjoys a positive carry some pressure on DKK will eventually remain". That proved to be right. We listed other factors that have received attention lately including the risk that foreign investors would not reinvest proceeds from forthcoming refinancing auctions, a potential repatriation of coupon money from government bonds, a general rise in risk aversion and M&A flows. We concluded that none of these is currently the driving factor behind the DKK.

The Political Agreement on Financial Stability between the Danish government and the financial sector has so far failed to stabilise the DKK. However, that was never its real intention. The agreement is designed to ensure sufficient liquidity to solvent banks by providing a safety net and affording full coverage for all claims by depositors and senior debt (unsecured unsubordinated debt). However, it was never intended to reduce pressure on the DKK.

In our view, the risk of further rate hikes has risen substantially (alternatively if ECB lowers its refi rate, DN could decide to lower its rates by less than ECB). DN has clearly shown that it will try to maintain EUR/DKK close to its central parity. We could see a repetition of actions taken in 2000, where DN felt forced to widen the rate spread to Euroland considerably in an attempt to stop pressure on DKK. This move proved effective and DKK appreciated against EUR following several months of higher DKK rates. When conditions in money markets begin to improve we believe DN will start to ease rates although it may be some time before this occurs.

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Published on  Wed, Oct 8 2008, 08:09 GMT