Danish short rates likely to be unchanged in 2016, 2017

With the ECB expected to further ease policy today, questions arise for the response of Danish central bank. In the past three months the Danish central bank has narrowed the interest rate differential to the ECB twice. The central bank is likely to permit narrowing of the interest rate differential for the third consecutive time. The forecast for unchanged interest rates in Denmark are based on two factors.

The Danish central bank, since April 2015 has intervened in the FX market at different degrees to offset a too sharp depreciation of the krone against the euro. However, the krone continues to be relatively weak against the euro in spite of intervention and is trading around its central parity.

Secondly, the intervention by the central bank has reduced the Danish currency reserves by DKK 296 billion to a post-December 2010 low. The excess money market liquidity has dropped sharply due to the reduction in reserves. This implies that the Danish central bank will support a slightly strong krone against the euro to avert additional liquidity-draining FX intervention.

Meanwhile, since the ECB's January meeting, the market has projected the ECB to in deposit rate by 10-15bp in March, while another easing is expected for later in 2016. In contrast to this, market does not expect the Danish central bank to make any changes in interest rate. The country's short rates - Cibor and CITA - are likely to remain unchanged in 2016 and also in 2017 if the current account limits are left as is.

"Market expectations for the ECB are thus largely in line with our view, but we believe that Danish short rates could move a tad higher than priced in by the market", says Nordea Bank.

The ECB, in very short term might ease monetary policy beyond expectations. Hence, a huge unexpected move by the ECB might compel the Danish central bank to cut its CD rate again. Moreover, the Swiss central bank is expected to mostly follow the ECB's move and lower rate by nearly 10bp next week and a total of 25bp in 2016. If the SNB does not cut its rates by the same proportion as the ECB, the Swiss franc can appreciate, which will then put a downward pressure on EUR/DKK.