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Denmark vows to keep currency peg, likely to cut rates on Thursday

Denmark's political and central banking establishment is uniting in a campaign to kill speculation that the country might follow Switzerland in scrapping a currency link to the euro.

[COPENHAGEN] Denmark's political and central banking establishment is uniting in a campaign to kill speculation that the country might follow Switzerland in scrapping a currency link to the euro.

With markets expecting upward pressure on the Danish crown to persist, most analysts predict an interest rate cut as soon as Thursday - which would be the second this week - if the European Central Bank moves to stimulate the euro zone economy.

But some also believe the Danish National Bank may eventually have to loosen the straitjacket in which it holds the crown against the common currency, while keeping within trading bands agreed with the European Union.

The Swiss franc has leapt almost 20 per cent against the euro since last week when the Swiss National Bank out of the blue ended a three-year-old policy of capping its currency.

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But in Copenhagen, politicians and officials alike are keen to get the message over that Denmark will not be ending its much older currency link. "The fixed rate currency policy has now been in force since 1982 and in that period it has served the Danish economy so well," Economy Minister Morten Ostergaard told Reuters. "The government will continue to stick to its present currency peg to the euro and the Danish central bank has all our support in carrying this out." Denmark is the sole remaining member of the ERM2 European exchange rate mechanism, in which a number of EU countries once kept their currencies within bands against the euro. The others, ranging from Cyprus and Malta to Slovenia and Lithuania, all subsequently left when they adopted the common currency.

However, Denmark will not be following them as it opted out of adopting the euro in 1992.

Under ERM2, the Danish and European Central Banks are obliged to keep the crown in a corridor of 2.25 per cent either side of a central parity exchange rate. In practice, the Danish National Bank has traditionally kept it in a much tighter range of plus or minus 0.5 per cent from the parity rate of 7.46038 crowns to the euro.

The Danish National Bank insists nothing has changed. "The policy remains the way it has been - namely that we maintain it close to central parity," the bank's director of communications Karsten Biltoft said on Tuesday. "We have the tools to react at any given moment." Backing for the policy, held in one form or another since the crown was pegged to the German mark more than three decades ago, also comes from across the political spectrum.

Even the eurosceptic Danish People's Party said it saw no reason for any change. "We recommend the Danish National Bank carries on in its effort to keep the Danish currency rate near the central rate of the euro," lawmaker René Christensen told Reuters.

The policy is born of necessity as the economy of Denmark, a small country of 5.5 million people, is tightly integrated with the EU. Just under two thirds of trade is with the bloc.

Denmark's currency relationship with the euro zone is much closer than Switzerland's. "The Danish crown, unlike the Swiss franc, is a euro in disguise," said Francesco Papadia, the former head of the ECB's financial market operations. "The decades-long peg first to the D-mark and then the euro makes it unlikely grounds to speculate against it." Nevertheless, the currency has been straining at the stronger end of the band since September, when the central bank began intervening by selling crowns. It is seen as a relative safe haven and while Danish interest rate policy has been in step with the ECB, actual rates were a touch higher until Monday's cut to -0.2 per cent, the ECB's level.

Now traders caught out by the complete shock of last Thursday's Swiss move don't want to repeat the experience should Denmark follow suit, giving more reason to buy the crown.

Some economists believe Denmark might impose its currency policy less zealously. "If there is a very massive speculative pressure to make the crown stronger, it cannot be ruled out that the Danish central bank will have to accept that the Danish crown will strengthen more than what it has tried to keep it under for the last many years," said Handelsbanken chief economist Jes Asmussen said. "But it is very hard for me to see how the central bank could be pressured to a degree where it would have to let the crown go out of the 2.25 percent range allowed in the ERM2 agreement." So far, only the Danish National Bank has been selling crowns to keep the currency down. But if the official ERM2 bands were breached, the ECB would be drawn into the battle.

Most analysts have said the National Bank is likely to cut rates again on Thursday should the ECB then announce a widely anticipated quantitative easing package, which could lead to the euro weakening.

A cut of 0.10 percentage points, as a few analysts expect, would bring Denmark's main policy rate to -0.30 per cent from -0.20 now, following Monday's cut. That would bring the rate below that of the euro zone. "If investors are forced out of euro assets because they are unable or unwilling to accept a very low or negative yield, then they are unlikely to move to another negative-yielding currency," analysts at Morgan Stanley said in a note.