Denmark’s Defense of Krone Peg Prompts Speculation of Rate Cut

(Bloomberg) -- Sign up for the New Economy Daily newsletter, follow us @economics and subscribe to our podcast.

The Danish central bank's defense of the krone's peg to the euro has prompted speculation that it may have to cut rates, at a time when most of the world moves closer to the end of easy money.

The krone has been testing the peg's limits, prompting the central bank to intervene in the foreign currency markets for a fifth straight month last Friday. Some economists say it's probably only a matter of time before a rate cut comes.

“Interventions can't continue endlessly,” says Sune Malthe-Thagaard, chief analyst at mortgage lender Totalkredit. Normally the bank doesn't intervene in the market more than a couple of months before adjusting rates, but with foreign currency reserves lower than earlier, “right now the situation isn't normal,” he said.

The central bank has bought foreign currency for 44.4 billion kroner ($7.1 billion) since February. While its chief mandate is to maintain the peg, it's not likely to welcome the prospect of a rate cut. The economy has recovered from pandemic lockdowns better than expected, and a booming housing market is already causing financial stability worries.

Malthe-Thagaard said the central bank will eventually have to resort to a rate cut if it's forced to keep intervening in the currency market. He sees that happening in October at the earliest.

Denmark, which does most of its trade with Europe, holds the record for negative rates after the central bank first resorted to them in 2012 to protect the peg.

Read More: Danish Central Bank Says Risk Is Building in Housing Sector

Jan Storup Nielsen, chief analyst at Nordea, is among those who don't expect an imminent rate cut. He said there's less liquidity in the krone market after the central bank bought almost 80 billion kroner at the start of last year to prop up the currency. He argues in a note that the central bank probably sees the current situation as an opportunity to release more liquidity into the market.

There are also signs that the period of strengthening is easing up. The central bank intervened in June for just 2.6 billion kroner. That's a fraction of the 22.2 billion-krone intervention in May.

The central bank is probably going to intervene this month as well, Jens Naervig Pedersen, chief analyst at Danske Bank A/S, said in a note, adding that a 10-basis point cut will probably be made within three months.