DENMARK’S policy makers cut interest rates further into negative territory yesterday in an attempt to keep the krone pegged to the euro.
The headline policy rate was cut from minus 0.5 per cent to minus 0.75 per cent.
The krone-euro peg is a decades long arrangement where the Danish central bank sets interest rates and intervenes in currency markets in order to keep the krone exchange rate fixed against the euro.
The euro is weakening due to a quantitative easing programme launched in Europe. Switzerland was also linked to the euro by an exchange rate ceiling, but recently abandoned it.
Denmark’s central bank noted that since the Swiss decision to end its euro ceiling there had been big inflows of money into Denmark, which would tend to increase the value of the Danish krone.
Steen Bocian, chief economist at Danske Bank – Denmark’s biggest bank – notes that Denmark is much less likely to abandon its peg because it has more foreign exchange reserves and removing the peg would be very politically unpopular – there are general elections in September.
Falling policy rates are impacting borrowing costs for companies and governments. “One way of analysing the yield [interest] of a bond is to separate it into two parts. The first part captures investors’ expectations for short-term interest rates through the bond’s lifetime, while the second part…captures the influence of all other factors,” said economist John Higgins from Capital Economics.
Other factors include things such as inflation and risk. Low inflation combined with low interest rates is forcing other rates down. The yield on 10 year German government bonds recently slipped below Japan’s, which has spent decades battling low inflation and is undertaking its own quantitative easing programme.
British government borrowing costs also hit – or are at – record lows including 10 year bonds and even 50 year bonds.