Danish central bank to follow normal reaction function, narrowing EUR-DKK monetary policy rate spread

The Danmarks Nationalbank yesterday stated that it kept the interest rates on hold. Hence, the interest rate on certificates of deposit is kept unchanged at -0.65% and the EUR-DKK monetary policy rate spread is narrowed to -0.25% from -0.35%. Earlier that day the ECB announce a package of easing measures that included interest rate cuts, expansion of QE to EUR 0.0% per month from EUR 60bn, a new TLTROII with a maturity of four years  beginning in June 2016 and it will begin buying investment grade non-bank corporate bonds.

Mario Draghi clearly hinted yesterday that he does not see any more rate cuts and that the ECB has decided against a tiered system to send signal on interest rates. As such, there is no likelihood that the Danish central bank will further lower rates in the near future.

"However, we expect DN to follow its normal reaction function, meaning that DKK10-20bn FX intervention outflow most likely will trigger an independent rate hike, thereby narrowing the spread between DN and ECB policy rates further", says Danske Bank. 

DN, in June 2014 had decided not to follow the ECB's 10bn rate cut because of the DKK0.8bn of FX outflow in May. This initiated the trend lower in EUR/DKK. DN is unlikely to allow EUR/DKK to drop below 7.45 to avert a repeat of the 2014-scenario. If the pair drops further, the central bank is expected to lower the interest rate on certificates of deposit to -0.75%, the lower bound on policy rate, and increase FX interventions. The central bank can sell unlimited amounts of DKK when foreign exchange flows into Denmark.