Danish central bank ends negative rates experiment

The National Bank of Denmark has increased its deposit rate into positive territory for the first time in almost two years – a decision that has shocked many local banks that forecast negative rates into 2015.

The Danish krone is pegged to the euro under the European Exchange Rate Mechanism (ERM II), and the central bank sets its interest rates at a level that will maintain the peg.

The central bank eased monetary policy steadily in the wake of the financial crisis and, as the benchmark rate approached the zero lower bound, it took the unprecedented step of cutting its deposit rate to -0.2% in July 2012.

The central bank, which does not set monetary policy according to a set schedule, increased the deposit rate to -0.1% in January 2013, but a number of Danish analysts expected it to remain in negative territory until the end of 2014/the start of 2015.

Today, the central bank increased the rate by 15 basis points to 0.05%, in an effort to mitigate the impact of tighter short-term interest rates in the eurozone on the krone.

Lars Peter Lilleøre, Nordea's chief analyst, said the timing of the decision had "come as quite a surprise", while he was also caught off-guard by the size of the increase.

"This move [from the National Bank] not only leaves negative rates behind, but also leaves Denmark with a higher deposit rate than the ECB for the first time in nearly two years," Lilleøre said.

Danske Bank issued a research note entitled ‘Another year of negative rates ahead' earlier this month, where it laid out five reasons the central bank would not hike its deposit rate for another 12 months – including governor Lars Rohde's apparent unwillingness to intervene in the foreign exchange market.

"It is important to remember that historically [the National Bank] has intervened before it has changed interest rates," the note said. "Hence, before an independent Danish rate hike may come on the agenda, [it] likely will have to step into the FX market."

The principle appears to be correct – if not the timing. The central bank revealed it had sold foreign exchange before making the decision to increase the deposit rate. It is yet to publish details of this intervention, however, and will only do so at the start of May.

The Reserve Bank of New Zealand (RBNZ) became the first major central bank to tighten interest rates last month, when it increased its benchmark rate by 25bp to 2.75%. The rate hike was, according to RBNZ governor Graeme Wheeler, the start of a tightening cycle.

The central bank increased the rate by another 25bp to 3% today, predominantly because "inflationary pressures are increasing and are expected to continue doing so over the next two years", and suggested that further hikes could follow.