Danish economy to expand below 1% in 2016, DN likely to keep rates on hold throughout 2016

Denmark’s GDP growth rebounded slightly after the very weak data recorded in Q3 2015. However, the economy is likely to grow below 1% for 2016 as a whole. Nevertheless, employment growth continues to be strong, with private sector adding 3,200 employees in January. Inflation in January had decelerated as expected but seems likely to remain positive before accelerating again in H2 2016.

In March 2016, Danmarks Nationalbank (DN) decided not to mirror the ECB’s 10 bp cut after it had to intervene in February to support the DKK. Hence, the central bank narrowed the DKK-EUR interest rate spread. The policy rate of Denmark was thus kept on hold at minus 0.65%.

The central bank is expected to keep the rates on hold at this level on a 12-month horizon. However, the risk is clearly that the accumulated 30bp of tightening relative to ECB since December has been very aggressive and that downward pressure on EUR/DKK will emerge. In particular if capital begins flowing into Danish krone as a hedge against uncertainty of the impact of UK EU referendum on the EUR. In such a case, DN is expected to take its normal reaction function that indicates DKK10-20bn in inflow will set off a reduction of 10bp to minus 0.75%.

Denmark’s money market is anticipated to rise gradually in Danish money market rates from 2017 and the spread towards EONIA is expected to turn positive in 2017. Hence, deposit rate is expected to be below market pricing.

The significant Danish current account surplus will ensure that the Danish policy rate can remain below that of the ECB in the near future. The ‘hunt for yield’ following the ECB’s stepped-up program is also likely to attract investors Denmark’s marginally higher yields. Hence, Danish yield spreads against Germany are expected to tighten somewhat throughout 2016.

“In respect of the 10Y rates we expect a slight upward pressure from higher USD rates and we look for a steeper curve 2Y10Y and 5Y10Y in 2016. We forecast that 6M CIBOR fixings will stay close to zero, whereas 3M fixings will edge further into negative territory in 2016”, says Danske Bank.