Denmark - Danish central bank introduces new lending facility

• Danmarks Nationalbank (DN) has just announced a new one-week lending facility with an interest rate of -0.50%.

• The facility will help cap upside in short-term DKK interest rates should a DKK liquidity shortage arise.

• In our view, it will also allow DN to draw down the FX reserve further to cap EUR/DKK upside and, hence, reduce the possibility of a near-term rate hike.

• The Danish government bond market has shown remarkably strong resilience to the spread widening seen in the semi-core and periphery.

Danmarks Nationalbank (DN) has just announced a new one-week lending facility. It will allow banks to borrow for one week at an interest rate of -0.50%. The interest rate on the permanent repo facility is +0.05%. The move will, de facto, narrow the interest rate corridor to -0.50% to -0.75%. It will help cap short-term DKK interest rates at -0.50%, as opposed to +0.05% if a liquidity shortage should arise in the DKK money market, e.g. following upward pressure on EUR/DKK and a significant drawdown on the FX reserve. DN said it currently does not see signs of strain in the money market.

We forecast EUR/DKK to continue to trade close to 7.4730 short term, as the current weak stock markets and low interest rates in Denmark are weighing on the DKK. In the remainder of March, seasonal dividend payments will further support a high level for the EUR/DKK. In addition, we expect a large discount in EUR/DKK FX forwards. However, in our view, the new lending facility provides DN more room to draw on the FX reserve, which was DKK429bn at the end of February, to support the DKK without having to raise interest rates. We still expect an independent 10bp rate hike from DN later this year, but see less probability of a hike in the short term should we see renewed outflow from the FX reserve.

The Danish government bond market has shown remarkably strong resilience to the spread widening seen in the semi-core and periphery, with only 2-4bp widening across the curve to Germany in the last three weeks. It is a similar picture in the DKK-EUR swap spreads, with also very limited widening relative to other markets.

It has been mainly callable mortgage bonds that have been hit lately, with callable bonds underperforming by nearly 2-4bp to swaps today and the 0.5'50 losing 70-75 cents to DGBs. The 0.5% 30Y have dropped almost 100 cents this week and the 1% 2050(io) bonds are close to being reopened. However, the spread widening in callables is much less than that seen in other markets, given ‘only' 10-12bp widening to swaps since the end of February. Furthermore, as the price of the 0.5% 30Y callables declines, it reduces the prepayment risk in the higher coupon bonds. Looking forward, there is a risk of a more spread widening, but if the issuance declines, there would be limited supply pressure and this should dampen pressure on the callables.

Longer flex bonds (4-5Y) have actually seen good buying interest this week, almost without any spread widening, whereas investors are selling shorter flex bonds to get cash for buying other assets (equities).

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