ECB’s QE Effect; Danish Central Bank Cuts Interest Rates Twice this week

Here is one interesting ramification from the ECB’s QE, the Danish central bank cut interest rate twice this week:

From the Wall Street Journal:

Denmark cut its main interest rate on Thursday for the second time this week as it sought to dampen interest in its currency among investors selling the euro after the European Central Bank announced a stimulus package.

The Danish central bank lowered its deposit rate to minus 0.35% from minus 0.2% after cutting from minus 0.05% on Monday. It left its other main interest rates unchanged.

The Danish move came ninety minutes after ECB President Mario Draghi announced an expansion of an ECB bond-buying program aimed at supporting growth and lifting inflation expectations in the eurozone. Mr. Draghi said the ECB will buy a total of €60 billion ($69 billion) a month in assets including government bonds, debt securities issued by European institutions and private-sector bonds.

The Danish currency the krone has been pegged to the euro, which means that Denmark has de facto part of the EMU via the ECB’s policies

And considering that the Swiss SNB abandoned the franc-euro cap last week, speculations have been rife that Denmark might do the same.

Back to the article:

Since last week’s surprise retreat by the Swiss central bank from its policy of limiting the rise of the Swiss franc against the euro, analysts have been wondering who might be next and focus has been on Denmark.

“It’s very clear that the Danish central bank is feeling the pressure,” said Peter Kinsella, a foreign-exchange strategist at Commerzbank. “The fact that they have acted twice in the space of just a single week shows that they are indeed very concerned.”

Some have wondered if Denmark’s peg might be vulnerable and the central bank has been quick to show it won’t shy away from cutting its main rate well into negative territory and intervening in the currency market if that is what is needed.

“We have the instruments necessary to maintain the peg, we have done today what we have done on previous occasions,” said central bank spokesman Karsten Biltoft by phone from Copenhagen. “First we intervene in the foreign exchange market, then we change the interest rate,” Mr. Biltoft said.

Denmark’s business leaders have reportedly appealed to the Danish central bank to maintain the peg.

Interestingly, for Denmark household debt has been the largest in the OECD.

From a January 2014 Bloomberg report

Denmark is reining in its $550 billion home loan industry, the world’s biggest per capita, after cheap credit fed a borrowing spree. Danes owe their creditors 321 percent of disposable incomes, a world record and a level that warrants a policy response, the Organization for Economic Cooperation and Development said in November.

Denmark’s consumers are backed by some of Europe’s biggest pension savings, at about 1 1/2 times gross domestic product, central bank figures show. While the structure of the nation’s housing market and pension system mitigates some of the credit risks, Noedgaard said debt levels are hampering consumer spending, which makes up half Denmark’s $340 billion economy…

Household borrowing from mortgage lenders and banks stood at 1.88 trillion kroner ($345 billion) in October, the majority of it home loans, after peaking at 1.91 trillion kroner in December 2012, according to central bank statistics.

Media notes that Denmark's debt levels have been hampering consumer spending. Of course, debt enables the frontloading of spending to the present. This has a cost: future spending. But the future has arrived, debt has to be paid at the cost of present spending. There is no such thing as a free lunch. If income doesn't grow debt levels will be a problem.

And according to a report from the European commission (March 2014):

Denmark's mortgage system is characterised by a high share of variable-rate and deferred amortisation loans. The share of variable-rate (or "adjustable rate") loans by mortgage banks remains high at 72% of total lending in November 2013. The variable rate loans are particularly widespread among families in the top 10% and the bottom 10% of the income distribution. The share of deferred-amortisation loans, i.e. loans with interest-only payments in the initial phase of the contract, is also high, amounting to 53% of total mortgage lending in November 2013.

The above highlights the sensitivity by Denmark's household balance sheets to changes in interest rates even if part of this has been "backed by pensions".

In other words, a surge in inflation expectations may spike interest rates which may may render Denmark’s economy vulnerable to a margin call. Add to this the fragile confidence on Denmark’s credit conditions which increases the possibility of markets to speculate against the peg.

This one reason why the Danish central bank will eventually follow the SNB.