Remember when Denmark’s central bank went negative, back in July?
After the ECB’s deposit rate went to zero, the Nationalbanken cut its own deposit rate, largely in order to stem capital inflows.
Quid pro quo Mr. Draghi, said the newly hip Danes.
“We have never been so popular,” laughed one Danish policy maker to the FT while hoping everyone ignored that Sweden had done the same thing back in 2009.
The Danes did their dastardly deed by setting a negative rate of (-0.20 per cent) on certificates of deposits with a maturity of 7 days.
They made at least some effort to mitigate the pain for the banking system by tripling the limit on current account deposits from DKr23bn to DKr70bn. That allowed banks to shift some money from deposits bearing a negative interest rate to the current account deposits, which offer a comparatively generous zero per cent.
And it seems, sensibly enough, that banks have been taking up the zero per cent option when they can. Chart via Rabobank:
But since we are talking about roughly DKr200bn of Danish bank deposits at the central bank there is still some pain to be taken.
How much pain is uncertain but Rabobank estimate that over the past year, the amount of liquidity placed on deposit has been very volatile (within a range of DKr66bn to 188bn), implying that the net annual cost for the banks of the decision may lie anywhere up to DKr300m (taking into account the allowed shift from certificates of deposit at negative rates to current account deposits at zero).
They also argue that the decision has proven succesful in the short term (with our emphasis):
In August (after the decision to push rates into negative territory), the central bank did not intervene in the foreign exchange market leaving reserves unchanged from July at DKK 514.4 billion. As can be seen, since early July, the currency has weakened against the euro. EUR/DKK is now trading only 0.06% below its central parity rate. From this we may infer that the policy measure has been – at least partly – successful.
(Although obviously, the risk reversal generally had a whole load to do with that move — the krone has been seen as an ideal hedge against euro-risk.)
But what about the longer term consequences?
As we have written before, Denmark’s negative rates have left Danish banks struggling to maintain their interest rate margins… which they, you know, need. That will have consequences as banks attempt to compensate or just founder.
And a large part of Denmark’s current advantage is surely its first mover position. If other banks follow, what then? Reduce the negative rate still further? Even putting aside the howls of a banking sector on the rack, Denmark would surely be back to interventionist square one.
So what can we learn from this Danish experiment?
For one thing, Denmark has shown that negative deposit rates are something that “can be done”without creating excessive volatility. The cut in the CD rate to -0.20% led to a shift in the entire DKK OIS curve. Initially the impact was biggest at the short-end, but this was followed by a flattening of the curve later. So, as negative deposit rates have helped to pull money market rates down this has contributed to downward rate pressures across the whole maturity spectrum, forcing investors to search for yield further up the curve. More generally, this could spur risk-seeking behaviour.
Overall, then, our conclusion is that the lessons from the recent Danish experience for European monetary policy makers are relatively limited. First of all, projecting the Danish situation on that of the eurozone only goes so far, as the main rationale for the Danish central bank was to stem the huge inflows of money. This is obviously not the problem in the eurozone. Secondly, the longer-term consequencesof such a policy remain largely covered in mist. And, undoubtedly, for a very different, large and diverse economic area such as the eurozone, other factors will have to be added to the equation.
Oh. Right then.
Bankers watch as Sweden goes negative – the FT (2009)
Money market funds close after ECB cut – the FT
Negativity at the door, euro money market fund edition – FT Alphaville