Denmark under pressure to abandon euro cap

Denmark could follow the lead set by Switzerland last month and abandon rules capping its kroner currency to the euro, as the kroner becomes too strong to maintain the link.

On Tuesday (3 February) the Danish National Bank will publish information about the size of its currency holdings in January - which are expected to show a flood of buyers for the kroner as investors look for a safe haven.

Having negotiated an opt-out from the single currency in the Maastricht treaty, Denmark instead joined the European Exchange Rate Mechanism (ERM2) in 1999, requiring the kroner to be kept within a plus or minus 2.25 percent band to the euro.

Danes then voted by a 53-47 percent margin to stay out of the single currency in a referendum in 2000.

Under ERM2, both the Danish central bank and the European Central Bank in Frankfurt are obliged to to keep the currency stable. In the process, however, the kroner is in danger of becoming too strong for policy-makers to maintain a fixed exchange rate with the euro.

Denmark’s efforts to defend its euro peg and stop investors buying kroner have driven its benchmark deposit rate to minus 0.5 percent, the third cut in less than two weeks.

Meanwhile, interest rates on 10-year government paper fell to 0.15 percent after the Danish central bank’s decision on Friday (30 January) to suspend bond sales.

It is more common for governments to worry that their cost of borrowing is too high and about dwindling foreign currency reserves, but Denmark has already sold enough bonds to cover its entire borrowing costs for 2015.

"The National Bank has the advantage that it can print new money. It never runs out of money, and that is what happens when it sends kroner out in the market to buy euro up. In this way the exchange reserve grows," says Steen Bocian, chief economist of Danske Bank told Borsen.

The euro has steadily weakened over the past year, hitting its lowest exchange rate against the dollar of 1:1.11 after the ECB announced plans for a €1.1 trillion bond-buying programme to weaken the euro’s exchange rate to promote exports and curb deflation.

The euro lost nearly 20 percent of its value in a day against the Swiss franc after the Swiss national bank abandoned a three year cap on the franc's value against the single currency in mid-January.

Explaining its decision, the Swiss National Bank (SNB) said that the minimum exchange rate of CHF 1.20 per euro, introduced in September 2011, was no longer justified because “divergences between the monetary policies of the major currency areas have increased significantly”.

“If the current exchange-rate mechanism was abandoned, the kroner would rise in price,” said Frederik I. Pedersen, chief consultant of The Economic Council of the Labour Movement according to Berlingske Tidende.