As the world finds itself enmeshed in something of a financial crisis as a butterfly flutters its wings in China thoughts turns to what might be called International Rescue. There has been call after call from investors for central banks to “do something” and presumably they are not asking the US Fed and the Bank of England to deliver on their promises of interest-rate hikes! However there are issues over what central banks have left in their toolkits especially in places like Denmark which have already plunged into an icy cold world for their official interest-rates.
Effective from 6 February 2015, Danmarks Nationalbank’s interest rate on certificates of deposit is reduced by 0.25 percentage point to -0.75 per cent.
Thus we are heading for nearly 7 months at such a level and in fact just under a year of continuous negative interest-rates as it was in early September last year that rates were cut to -0.05%. This added to the policy of negative interest-rates which began in July 2012 and which Denmark had tried to escape before plunging back into them. The Danish Nationalbank crossed quite a Rubicon back then.
For the first time in its nearly 200-year history, one of Danmarks Nationalbank’s interest rates is negative.
The cause of all of this as so often is the Euro as Denmark faces the cost of being a small country trying to float next to a behemoth.
The negative rate of interest on certificates of deposit was set solely with consideration to maintaining Denmark’s fixed-exchange-rate policy. The fixed-exchange-rate policy entails that monetary policy is laid down with a view to stabilising the krone against the euro.
So we note that should we see a further crash then for Denmark a repeat of the 9/11 response or the response to the 2007/08 crash would mean it going ever more negative in terms of interest-rates.
One of the problems of pegging yourself to a currency is that you inherit its problems. After a period of cutting interest-rates in response to a weak Euro Denmark has over the last few days faced a stronger one. The calls for the Euro to fall to parity against the US Dollar have been replaced by a reality of a rise to 1.16 or so versus it. Rather ironically we saw the main two QE (Quantitative Easing) central banks facing stronger currencies as the Yen surged too and at one point the two currencies values against the US Dollar crossed over which was rather extraordinary.
By EU reckoning 6% appreciation in TWI has same eco effect as a 100bp interest rate hike
That has happened since mid-April and does not fit the lower Euro theme at all. It also shows a cost of pegging your currency especially to a currency bloc with a list of troubles. The situation is worse if you use the Bank of England rule of thumb as it would consider the recent currency appreciation to be equivalent to a 1.5% interest-rate increase.
So they cut interest-rates to prevent a currency rise and then got one anyway by default! Time for some Fleetwood Mac.
Now, when I talked to God I knew he’d understand
He said, “Stick by my side and I’ll be your guiding hand
But don’t ask me what I think of you
I might not give the answer that you want me to
The real economy
The official view is that things are going rather well or “on track” as you might say.
The upswing is expected to gain strength in the coming years. Growth in real GDP is forecast at 2.0 per cent this year and 2.1 per cent next year. A slightly lower growth rate of 1.8 per cent is expected in 2017, when the economy reaches its normal capacity.
Ah yet more output gap theory. It persists in so many places which shows that reality is often not a friend of official views. However the new Danish government has just announced numbers which are not quite so optimistic. From Bloomberg.
The Liberal government of Prime Minister Lars Loekke Rasmussen sees gross domestic product expanding 1.5 percent this year, compared with 1.7 percent estimated by the Social Democrat-led coalition that was ousted in June elections. GDP will expand 1.9 percent in 2016, also less than the 2 percent previously foreseen, the Finance Ministry said.
Splitting hairs maybe but it has had more of an impact on the expected public finances.
The Finance Ministry in Copenhagen said the budget deficit in 2015 will be more than twice as big as previously estimated, mostly due to a slump in taxes from Danish pension assets.
That seems somewhat odd as Danish equity markets are still up on the year so perhaps we are seeing an effect of negative interest-rates, as I have expected them to hit pension funds and other longer-term contracts, but the new numbers are shown below.
The budget deficit was revised to 2.7 percent of GDP this year, more than twice the 1.3 percent previously estimated. The gap will widen to 2.8 percent next year, the Finance Ministry said.
Oh and readers of my post on the 4th of this month will not be surprised to see that I noted this bit too.
House prices will rise 6.5 percent this year and 4 percent in 2016, according to the Finance Ministry. Prices rose 3.4 percent in 2014.
Good news or not?
The country’s households, which carry the rich world’s biggest gross debt loads relative to disposable incomes…
One ominous feature of these times is to be top of en economic table and on that score I present this from John Kay in the Financial Times from late June.
For foreign policy experts, America is number one. But, from an economic perspective, the Danes win….. The wealth of Denmark is instead built on exporting bacon and drugs to control diabetes — an appropriate combination — around the world.
It is dangerous to be top of an economic league table in these times as calamity is often hiding around the corner. But we see that like the UK situation any financial meltdown will be transmitted to the real economy to a large degree by the housing market. This is awkward to say the least when it is not only official interest-rates which are negative. From the Danish Federation of Mortgage Lenders.
Some of the approaches where negative interest rates pass through to borrowers are being put to use.
Rather than returning actual cash they are mostly reducing the capital owed. Oh and what could go wrong?
The Danish mortgage model is regarded as being one of the best of its kind in the world. It contains a unique balance principle and a market-based repayment system. Hence, the Danish mortgage credit market is characterised by transparency, competition and stability.
A financial crash would challenge this for obvious reasons in a world where the Danish mortgage banks apparently think that the new Basel regulations should not apply to them. But if we move to my subject of the day which is how would Denmark respond? I would expect them to cut interest-rates even further especially if the Euro were to follow the pattern this time around and rally. At which point the famous words of William Shakespeare might then be heard one more time.
Something is rotten in the state of Denmark.