Danish Central Bank Matched ECB Rate Cut of 50 Basis Points

November 6, 2008

Denmark opted out of the common European currency but participates in ERM2, whereby domestic credit policy is subordinated to the goal of having the krone shadow the euro. Normally, the Dansmarks NationalBank adjusts its benchmark lending rate in tandem with the ECB and in fact matched all eight ECB rate hikes of 25 basis points between December 2005 and June 2007. This year, selling pressure on the krone has forced the central bank into running a comparatively more restrictive stance than the ECB. The ECB’s last rate hike of 25 bps on July 3 was of course matched by Denmark, but Denmark in addition implemented unilateral rate increases of 10 basis points in Mid-May, 40 bps on October 7, and 50 bps on October 24th, and the ECB’s first rate cut of 50 bps on October 8th was not copied by Denmark’s central bank. Up to yesterday, Danish rates had climbed 125 basis points since end-2007 to 5.5%, whereas the ECB’s refinancing rate had dropped by 25 bps to 3.75% on balance. The Danish premium had widened 150 bps as a result to 175 bps. Pressure on the krone in October alone had forced Danish monetary authorities to sell Dkr 63.9 bln of foreign currency in intervention support, an amount equivalent to 40% of end-September currency reserves. Part of that drop was replenished by swap drawings, but the situation was not sustainable and prompted the undesirable monetary policy response of lifting interest rates in the teeth of a regional and global recession.

None of that inconvenience would have been necessary if Danish voters had not twice voted down referendums to accept the euro as Danish currency. Another referendum is being considered now. It was in the meantime not clear how Denmark’s central bank might react to an ECB rate reduction. Apparently, officials now felt Danish interest rates are now sufficiently above Euroland levels to defend the krone parity against the euro. The statement released by the Danish Central Bank today does not comment on economic prospects but merely says the reduction was precipitated by a similar modification in ECB rates. In total, four Western European central banks cut rates today, the Bank of England by a gigantic 150 basis points and the central banks of Switzerland, Denmark, and the euro area by 50 basis points each. Today’s Danish rate cut was the first since mid-2003.

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