Danish central bank sells DKK in FX intervention in May; likely to keep interest rate on certificates of deposit unchanged

The Danmarks Nationalbank (DN) has intervened in the FX market again in May in an attempt to keep the Danish krone from strengthening too much against the euro. The Danish central bank published its May FX reserve and central bank balance data that shows that DN sold DKK 24 billion in FX intervention. This has increased Denmark’s FX reserves to DKK 426.9 billion in May from April’s DKK 404 billion. This is the first time that the Danish central bank sold the Danish krone in FX intervention since February 2015.

DN is likely to have sold krone in the last two weeks of May in order to cap the EUR/DKK pair downside as it was trading below 7.4400. Denmark’s Debt Management Office bought back government bonds worth around DKK 5 billion in May. Moreover, in the past three months, buybacks have reached about DKK 13 billion. There is a leeway for buybacks to continue as the deposits of governments continue to be large, said Danske Bank in a research report. More buybacks will further restrict the requirement of FX intervention to limit EUR/DKK downside. The Danish krone is expected to be underpinned by a tighter policy spread to the ECB, added Danske Bank.

“We forecast EUR/DKK will trade at 7.4375 on 1-12M with downside risk to 7.4350, where we look for DN to cap EUR/DKK through FX intervention”, noted Danske Bank.

Usually, a strong intervention has set off an independent rate cut from the Danish central bank. But, in spite of a strong intervention, an independent rate cut is unlikely any time soon, said Nordea Bank in a research report. Selling the krone in FX intervention is expected to be sufficient for the central bank as this will raise DN’s net positions and push down short-term money-market rates and push forward EUR/DKK FX further into negative territory.

“We expect DN to keep the rate of interest on certificates of deposit unchanged at minus 0.65% in 12M. However, if the need to sell DKK in FX intervention accelerates, DN may opt to cut to minus 0.75% – a level we still view as the lower bound for the key policy rate in Denmark”, added Dankse Bank.

The FX reserves continue to be slightly lower than the average level seen in recent years. Against this backdrop, the DN might use intervention to keep the krone from appreciating further. However, this situation might extremely change if the UK votes to exit the EU during the referendum on 23 June. If that happens, financial markets are expected to consider Denmark as a safe haven. This might lead to huge inflows of capital into Denmark and hence set off independent rate cuts and also a likely Danish bond purchase program that is similar to that of the ECB, noted Nordea Bank.