DANMARKS NATIONALBANK MONETARY REVIEW 1 ST QUARTER

Transcription

1 DANMARKS NATIONALBANK MONETARY REVIEW 1 ST QUARTER 215

2

3 DANMARKS NATIONALBANK MONETARY REVIEW 1 ST QUARTER 215

4 MONETARY REVIEW 1 ST QUARTER 215 Text may be copied from this publication provided that Danmarks Nationalbank is specifically stated as the source. Changes to or misrepresentation of the content are not permitted. The Monetary Review is available on Danmarks Nationalbank s website: under publications. Managing Editor: Per Callesen Editor: Niels Lynggård Hansen This edition closed for contributions on 11 March 215. Enquiries can be directed to: Danmarks Nationalbank, Communications, Havnegade 5, DK-193 Copenhagen K Telephone (direct) or Office hours: Monday-Friday 9. a.m.-4 p.m. kommunikation@nationalbanken.dk ISSN (Online)

5 CONTENTS 7 CURRENT ECONOMIC AND MONETARY TRENDS 39 THE DANISH KRONE UNDER PRESSURE IN JANUARY-FEBRUARY 215 ARTICLES 51 FALLING OIL AND CONSUMER PRICES Anne Ulstrup Mortensen and Jonas Staghøj, Economics Consumer prices have fallen over the last year, not least because the price of crude oil halved from the summer of 214 to January 215. In January, the overall consumer price index was thus lower than a year earlier. A negative annual rate of increase in the consumer price index is not the same as deflation, however. Instead, the term deflation can reasonably be used to describe a period of general and sustained price falls. In the current situation, there is no prospect of consumer prices continuing to fall, and wage growth is also positive. Hence, there is no deflation. The direct effect of the oil price fall on the rate of increase in consumer prices is temporary, unless oil prices decline further. Thus, the actual risk of undesirable price developments is that the substantial price fall will spread to other goods and services via the wage formation. This could exacerbate the immediate price fall and ultimately trigger a negative self-reinforcing wage-price spiral. The risk of that happening remains limited. 67 FAVOURABLE TREATMENT OF GOVERNMENT BONDS IN FINANCIAL REGULATION Brian Liltoft Andreasen, Morten Niels Haastrup, Thorsten Meyer Larsen and Lindis Oma, Financial Markets In financial regulation, government bonds are in several respects treated as if they were risk-free. Regulation affects banks' behaviour, and failure to take the risks on certain assets into account may distort the banks' investment decisions. Hence, regulation may give banks an incentive to make disproportionately large investments in government bonds. Favourable treatment of government bonds applies when calculating risk weights, in the regulation of large exposures and in the new liquidity regulation. Danmarks Nationalbank finds it positive that the treatment of sovereign exposures in financial regulation is being reconsidered at the international level.

6 79 INITIAL EXPERIENCE WITH INSTANT PAYMENTS Anders Tofthøj Andersen, Payment Systems, and Tommy Meng Gladov, Administration In November 214, it became possible for citizens and firms in Denmark to make instant payments. They can be made through online banking, mobile banking, Swipp or MobilePay. The daily number of instant payments averages 13,. A considerable part of the use can be attributed to Mobilepay and Swipp payments, which are all made as instant payments. Instant payments were facilitated in a joint effort by the Danish financial sector and Danmarks Nationalbank as part of the final phase of the large-scale modernisation of the Danish payments infrastructure. The article describes the initial experience with the use of instant payments and outlines the system behind instant payments, including how their finality is ensured. Vol. LIII, No. 1

7 CURRENT ECONOMIC AND MONETARY TRENDS SUMMARY Global economic activity is gradually picking up. An upswing is underway in the USA and the UK, where especially growth in domestic demand is strong. In the euro area and Japan, growth is more moderate. Activity in the advanced economies is supported by low energy prices and low and declining interest rates. In the euro area and Japan, growth is also being boosted by weak exchange rates, and for the euro area as a whole fiscal policy is expected to be more or less neutral in 215. Overall, growth in the global economy is expected to accelerate in the coming years. In January, the European Central Bank, ECB, decided to ease monetary policy further. Consequently, the ECB has expanded its existing asset purchase programme substantially and in March began to purchase government bonds and other securities for a total of 6 billion euro per month. Initially, these purchases will continue until end-september 216. Also in January, Schweizerische Nationalbank abandoned the minimum exchange rate of the Swiss franc vis-à-vis the euro. Immediately after the announcement the franc strengthened considerably, and subsequently the Danish krone came under upward pressure in January. Danmarks Nationalbank purchased foreign exchange and reduced the rate of interest on certificates of deposit on four occasions in January and early February, to -.75 per cent. This is an all-time low for a Danish monetary policy interest rate. The very low level of interest rates, falling oil prices since last summer and the weakening of the effective krone rate are key factors contributing to higher growth in the gross domestic product, GDP, this year and in the coming years. GDP growth in Denmark is expected to be 2. per cent this year and to remain at that level in 216 and 217. The projection thus reflects continuation and strengthening of the upswing that has already been underway for some time. The forecast growth in the economy is sufficient for the output gap, which was around -2 per cent of GDP at the end of 214, to close over the next couple of years. In February 215, consumer prices were at the same level as one year earlier. The main reason for the subdued price development is the plummeting oil prices since last summer. However, deflation is not on the cards as core inflation is positive and wage growth is positive and rising marginally. Fiscal policy should take into account the strong expansionary forces currently at work. An economy in an upswing, with a negative output gap that is gradually closing, requires bringing back fiscal policy a neutral stance. In other words, the structural balance, which is close to the lower limit of -.5 per cent set by the Budget Act, should be brought close to balance over the next couple of years. In addition, recent years structural reforms, including the reforms of the unemployment benefit and pension systems, should result in a steady increase in the labour force; if not, a shortage of labour will soon arise. The housing market is picking up, but there is a risk that a prolonged period of very low interest rates will trigger an unhealthy development with DANMARKS NATIONALBANK MONETARY REVIEW 1 ST QUARTER 215 7

8 self-reinforcing price rises for owner-occupied dwellings. The lack of sufficient automatic stabilisers in the housing market is a problem. The most effective way to strengthen macroeconomic stability and dampen fluctuations in the housing market is by restoring the link between property value and property taxation which existed before 22. This cannot wait until 22. THE INTERNATIONAL ECONOMY AND THE FINANCIAL MARKETS ECONOMIC DEVELOPMENT AND GROWTH OUTLOOK Global economic activity is gradually picking up. Among the advanced economies, growth is particularly strong in the USA and the UK, while it is more moderate in the euro area and Japan. Among the emerging economies, China is still experiencing strong, albeit declining, growth. In the euro area, GDP grew by.3 per cent in the 4th quarter of 214, cf. Chart 1 (left). A re covery was seen in most euro area member states, with Germany and Spain, among others, achieving a growth rate of.7 per cent. In France and Italy, GDP was more or less flat. The Purchasing Managers Index, PMI, which provides a good indication of where the economy is heading, points to further growth in GDP in the 1st quarter of 215. In both the USA and the UK, growth subsided a little in the 4th quarter. US GDP grew by.5 per cent, down from more than 1 per cent in the preceding two quarters, cf. Chart 1 (right). In both countries, the recovery is driven mainly by strong domestic demand. The PMI indicator for the USA points to continued robust growth. In Japan, GDP increased by.4 per cent in the 4th quarter, after having contracted in the preceding two quarters. Overall activity in the international economy is supported by a drop of approximately 5 per cent in the price of oil since it peaked at more than 11 dollars per barrel in June 214, cf. Chart 2 (left). But the effects of the price fall vary strongly across countries. Lower oil prices result in losses for oil producers, including Russia, Norway and members of OPEC (Organization of the Petroleum Exporting Countries). On the other hand, they entail a gain for oil consumers, including the advanced economies, where terms of trade improve and real disposable incomes rise. Production costs also fall, which is a competitive advantage for countries such as China that have highly energy-intensive production. For the euro area, the saving on net imports of oil amounts to just under 1 per cent of GDP, cf. Chart 2 (right). The saving would have been slightly larger if the euro had not weakened against the dollar in the same period. Besides lower oil prices, the recovery in the advanced economies is supported by low and falling interest rates, and by weaker exchange rates in the cases of e.g. the euro area and Japan. In addition, the pace of fiscal consolidation has slowed down considerably, and for the euro area as a whole fiscal policy is expected to be broadly PMI and GDP growth in the euro area (left) and the USA (right) Chart 1 Index 65 Per cent, quarter-on-quarter 1.5 Euro area Index 65 Per cent, quarter-on-quarter 1.5 USA PMI GDP growth (right-hand axis) PMI GDP growth (right-hand axis) Note: Composite output PMI for the services and industrial sectors. A value above (below) 5 indicates positive (negative) growth. Source: Reuters EcoWin and Thomson Reuters Datastream. 8 DANMARKS NATIONALBANK MONETARY REVIEW 1 ST QUARTER 215

9 Oil price (left) and saving on net imports of oil (right) Chart 2 Dollars per barrel Jan 11 Jan 12 Jan 13 Jan 14 Jan 15 Oil price (Brent) Per cent of GDP India Japan Euro China USA RussiaNorwayOPEC Saving, incl. change in exchange rate Saving at constant exchange rate Note: Right-hand chart: An oil price drop from 11 to 6 dollars per barrel has been assumed. The volume of net imports/exports has been kept unchanged. For net imports of oil, data for the USA is from 213, data for China, India, Russia and OPEC from 21 and data for other countries from 212. GDP figures relate to 214. The exchange rates are from 1 July 214 and 1 March 215. Source: Thomson Reuters Datastream and own calculations. neutral in 215, cf. Chart 3 (left). To the extent that changes in oil prices, exchange rates and interest rates since mid-214 are permanent and the transmission is complete, this will provide a substantial stimulus for growth in the euro area in particular, cf. Chart 3 (right). For the USA, on the other hand, the strengthening of the dollar will to some extent offset the positive effects of lower oil prices and interest rates. The strengthening of the dollar against the euro mainly reflects the different cyclical positions and levels of interest rates in the two economies. In the euro area, the low and falling interest rates and the weakening of the euro are partly attributable to the ECB s announcement on 22 January that it would expand its existing asset purchase programme considerably, cf. Box 1. From March, the ECB will be purchasing government Fiscal tightening (left) and impulses from exchange rate, interest rates and oil price (right) Chart 3 Per cent of potential GDP Fiscal tightening Euro area USA GDP effect after 2 years, per cent Exchange rate Interest rates Oil price Euro area USA Note: Left-hand chart: Fiscal tightening measured as the change in the primary structural balance relative to the preceding year. A multiplier of -1 has been applied. Right-hand chart: Based on elasticities from the ECB, IMF and OECD. Data concerns changes in the price of oil, exchange rates and yields on 1-year government bonds from June 214 to February 215. Interest rates have fallen most sharply in the euro area, while interest rate elasticity is higher for the USA. All shocks are assumed to be permanent. The effects cannot be summed directly as there may be overlaps and non-linearity. Source: Thomson Reuters Datastream, ECB, IMF, OECD and own calculations. DANMARKS NATIONALBANK MONETARY REVIEW 1 ST QUARTER 215 9

10 The ECB s asset purchase programme comparison with other asset purchase programmes and potential effects Box 1 On 22 January, the ECB announced an expansion of its existing asset purchase programme. The ECB cited lower inflation and inflation expectations as the reasons for its decision and said that the risk of a prolonged period of inflation below the target had increased. According to the ECB, the aim of the programme is to reduce market interest rates and improve access to credit for households and firms. This will support investment and consumption and ultimately contribute to bringing inflation closer to 2 per cent again. In March, the ECB began to purchase government bonds with maturities of 2-3 years, among other securities. Purchases, including the existing purchase programmes, will total 6 billion euro per month and will initially continue until September 216. However, the precise termination date will depend on when inflation approaches the ECB s target. These purchases will increase the ECB s balance sheet by around 1,14 billion euro, corresponding to approximately 12 per cent of the euro area s GDP, until September 216, cf. the left-hand chart below. Instead of direct purchases the ECB has previously increased its balance sheet via loans at low interest rates to European banks, against e.g. government bonds as collateral. Until 212, the ECB s balance sheet thus grew just as much as those of the Federal Reserve, Fed, and the Bank of England, BoE. However, since mid-212, demand from banks for loans of this type has fallen, which has reduced the ECB s balance sheet. The announced purchases by the ECB are smaller than the aggregate purchases in the period by the Fed and the BoE. However, the monthly purchases are of the same size. The Fed implemented three different asset purchase programmes in the period 28-14, purchasing mainly mortgage-backed securities and Treasury bonds totalling approximately 21 per cent of GDP (3,6 billion dollars): The BoE launched two programmes, purchasing mainly government bonds totalling approximately 22 per cent of GDP (375 billion pounds). Most surveys indicate that especially the first two purchase programmes from the Fed and the BoE worked as intended by reducing market interest rates and thereby strengthening activity. The greater effect of the first programmes is partly attributable to more dysfunctional financial markets at the beginning of the financial crisis. For example, risk premiums on mortgage bonds were very high. 1 More specifically, long-term government yields are estimated to have fallen by percentage points most strongly in the UK as a result of the 28 programmes. The later programmes are also estimated to have reduced market interest rates, but only by around.1-.2 percentage points. The announcement of the ECB s purchase programme meant that government yields fell in a number of countries, especially the southern euro area member states. The impact on e.g. German government yields was smaller. The fall in yields was greatest for 3-year government bonds, cf. the right-hand chart below. This is presumably because it took the market by surprise that the ECB was willing to purchase bonds with a maturity of 3 years. In contrast, the ECB s purchases of 1-year bonds were expected and hence yields did not fall as sharply. In addition, the announcement had an immediate effect on both long-term market-based implied inflation expectations and exchange rates. Inflation expectations rose from 1.5 to 1.7 per cent, and the euro weakened by 2-3 per cent against the dollar. Higher inflation expectations reduce the expected real interest rates and may thereby increase investment and consumption. A weaker euro pushes up import prices in the euro area and exerts upward pressure on consumer prices. At the same time, export prices in dollars are reduced, which improves competitiveness. Central bank balance sheets in selected economies (left) and selected government yields (right) Per cent of GDP in USA UK Euro area Per cent Jan 16 Jan 31 Jan 15 Feb 2 Mar Italy, 1 years Italy, 3 years Spain, 1 years Spain, 3 years Portugal, 1 years Portugal, 3 years Note: Left-hand chart: The broken line shows the projection of the ECB s balance sheet as a result of purchases of 6 billion euro a month from March 215. Right-hand chart: Par yields. The vertical line indicates 22 January, when the ECB announced the expanded asset purchase programme. Source: Reuters EcoWin, Thomson Reuters Datastream, OECD, Nordea Analytics and own calculations. 1. Cf. Bjarke Roed-Frederiksen and Christian Helbo Andersen, Unconventional monetary-policy measures, Danmarks Nationalbank, Monetary Review, 1st Quarter 213, Part 1. 1 DANMARKS NATIONALBANK MONETARY REVIEW 1 ST QUARTER 215

11 GDP growth forecasts for selected economies Table 1 Change relative to November 214 Per cent USA Euro area Germany France Italy Spain UK Japan China Note: Data for 214 are forecasts for Japan and China. Data for 215 and 216 are forecasts for all countries. Source: Eurostat and European Commission s winter forecast, February 215. bonds and other securities for a total of 6 billion euro per month. This measure was to some extent expected. Consequently, interest rates actually fell and the euro weakened before the purchase programme was announced. The European Commission has revised its growth forecasts for 215 and 216 upwards for most advanced economies, including the euro area, cf. Table 1. The upward adjustments are somewhat smaller than the positive impulses from oil prices, interest rates and exchange rates as shown in Chart 3 (right). One of the reasons could be that the impulses are high-side forecasts as changes in the three factors are assumed to be fully transmitted and permanent. In addition, the positive impulses were to some extent already included in the Commission s November forecast. Overall, global growth is expected gradually to accelerate in 215 and 216. In its January forecast, the IMF takes a slightly more negative view of the growth outlook for 215 and operates with somewhat lower growth in 216 than the Commission does. Both projections point out that growth may be higher than expected, e.g. due to positive effects of the low oil price. In the euro area, the falling interest rates and the weakening of the euro may also lead to surprisingly positive growth. On the other hand, renewed turmoil in the financial markets and the conflict between Unemployment, selected countries Chart 4 Per cent of labour force Per cent of labour force Euro area Germany France Italy USA Spain (right-hand axis) Source: Thomson Reuters Datastream. Ukraine and Russia are risk factors that may have a downward impact on growth. LABOUR MARKET AND INFLATION In the USA, unemployment fell to 5.5 per cent in February, cf. Chart 4. In the euro area, it fell to 11.2 per cent in January, but there are large differences across member states. Unemployment in Spain has fallen considerably since it peaked in the spring of 213, but remains high. In Germany, the rate of unemployment is below 5 per cent. DANMARKS NATIONALBANK MONETARY REVIEW 1 ST QUARTER

12 The decline in US unemployment from 21 to 214 reflects a notable increase in employment as well as a lower participation rate, cf. Chart 5. The latter is to some extent attributable to an increase in the number of pensioners, but more people also gave up finding a job. The improved employment outlook means that some of the people in the latter group are beginning to return to the labour market. In the euro area, the participation rate for year-olds has risen steadily over a Participation rates of year-olds in the USA and the euro area Per cent USA Euro area Chart Note: year-olds in the labour market relative to the entire population aged Source: OECD. number of years, including during the crisis. This has contributed to a rise in unemployment in the short term. In the longer term, the larger labour force will boost GDP. The low rate of unemployment in the USA means that spare capacity in the labour market is close to zero. As a result, wage growth accelerated in the latter half of 214, cf. Chart 6 (left). However, wage pressures are to some extent countered by a rising supply of labour as the participation rate is rising slightly and part-time workers would like full-time employment. But both firms and households expect wage growth to accelerate further in 215. In the euro area, wage growth is weak in many member states, reflecting the high rate of unemployment. In Italy and Spain, wages increased by less than 1 per cent on average in 214, and in France wage growth declined to approximately 1.5 per cent. In Germany, where unemployment is low, wage growth has increased since mid-213, to nearly 2 per cent in the 3rd quarter of 214. The collective agreements already concluded in 215 and the ongoing bargaining point to higher wage growth in 215. Since consumer price inflation is generally low, partly as a result of the development in energy prices, real wages are growing at a robust pace even though nominal wage increases are moderate. Presumably this is one of the reasons why households expect their finances to improve sub- Wage growth (left) and inflation (right) in the euro area and the USA Chart 6 Per cent, year-on-year Jan 12 Jul 12 Jan 13 Jul 13 Jan 14 Jul 14 Jan 15 Euro area USA Per cent, year-on-year Jan 12 Jul 12 Jan 13 Jul 13 Jan 14 Jul 14 Jan 15 Euro, inflation Euro, core inflation USA, inflation USA, core inflation Note: Left-hand chart: Private sector wages. Labour Cost Index, Business Economy, Wages and Salaries for the euro area. Employment Cost Index, Wages and Salaries, Private Industry for the USA. Right-hand chart: HICP for the euro area. CPI for the USA. Source: Thomson Reuters Datastream. 12 DANMARKS NATIONALBANK MONETARY REVIEW 1 ST QUARTER 215

13 Inflation expectations Chart 7 Development in real GDP per capital Chart 8 Per cent Jan 14 Apr 14 Jul 14 Oct 14 Jan 15 Break-even inflation, 5 years in 5 years, euro area Break-even inflation, 5 years in 5 years, USA SPF, inflation in 5 years, euro area Index, 1995 = Greece Spain Italy Portugal Euro area Note: SPF is the Survey of Professional Forecasters. Break-even inflation is based on inflation-linked swaps. Source: Bloomberg and Thomson Reuters Datastream. Source: Eurostat and own calculations. stantially in 215, cf. the European Commission s consumer survey from February 215. In most advanced economies, consumer price inflation declined towards the end of 214 due to the diving energy prices. In the euro area, the annual rate of increase in the consumer price index was negative in December and fell to -.6 per cent in January, cf. Chart 6 (right). However, it rose to -.3 per cent in February. Core inflation, i.e. the development in consumer prices excluding energy and food, has been more stable. In the euro area it has fluctuated between.7 and 1. per cent over the last year, but fell to.6 per cent in January and was unchanged in February. This mainly reflects considerable spare capacity in the economy. US core inflation is somewhat higher. The fall in oil prices and resultant lower inflation have caused market-based expectations of long-term inflation to decline in both the euro area and the USA since the summer of 214, cf. Chart 7. This points to the market assessing the risk of more permanent low inflation to have increased. However, inflation expectations rose again after the ECB s further easing of monetary policy on 22 January. Questionnaire-based longterm inflation expectations have fallen less, but are nevertheless below 2 per cent. GREECE GDP per capita in Greece rose strongly from 1995 until the beginning of the financial crisis, and by far more than in other southern European countries, cf. Chart 8. The strong economic downturn in connection with the financial crisis meant that, overall, growth in GDP per capita from 1995 to 214 was a little weaker than in e.g. Portugal, but considerably stronger than in Italy. However, the latter is at a higher level. In 214, the Greek economy began to improve. GDP grew by.6 per cent on average in the 1st to 3rd quarters, but in the 4th quarter it contracted by.4 per cent. At the same time, political uncertainty arose and an election was called for 25 January 215. At present, Greece has a loan programme totalling 173 billion euro. The euro area member states contribute 145 billion euro in the period The IMF contributes 28 billion euro in , provided that an EU loan programme also exists. So far, a total of 154 billion euro has been paid out under the existing programme. The new Greek government has obtained an extension of the loan programme with the euro area member states until the end of June, partly in order to have the final programme review approved before the last disbursement can be made. The extension was granted on the basis of the terms and conditions of the existing programme. Greece has presented a number of proposals for reforms that will be included in the final programme review. These measures will be specified in further detail and finally agreed with the Eurogroup by the end of April. The political uncertainty in Greece has caused equity prices to fall and government bond yields DANMARKS NATIONALBANK MONETARY REVIEW 1 ST QUARTER

14 Equity prices (top left), yields on 1-year government bonds (top right), composition of Greek government debt (bottom left) and foreign banks claims on Greece (bottom right) Chart 9 Index, 1 Jan. 214 = Jan 14 Apr 14 Jul 14 Oct 14 Jan 15 Apr 15 Greece, banks Greece, total Euro area, total Per cent Jan 14 Apr 14 Jul 14 Oct 14 Jan 15 Apr 15 Greece Portugal Italy Spain Billion euro Q1 21 Q2 214 Greek central bank Greek private sector IMF, euro area member states, etc. Foreign private sector Billion euro Q1 21 Q3 214 Germany UK France Other Europe Rest of world Note: Top charts: The vertical lines indicate 25 January, when a general election took place in Greece. Source: Thomson Reuters Datastream, IMF and Bank for International Settlements, BIS. to rise, cf. Chart 9 (top left and right). The benchmark Greek stock index, Athex, dropped sharply in the days after the election on 25 January, but has subsequently risen again. In addition, retail customers mainly households reduced their deposits in Greek banks by more than 17 billion euro in December and January. The financial turmoil has been contained within Greece and hence there have not been any spill-over effects in other EU member states. This reflects full market confidence that they can and will meet their payment obligations. At the same time, the private sector exposure to Greece has decreased strongly and most of the Greek sovereign debt (approximately 82 per cent) is now held by international official lenders, including the IMF and the euro area member states, cf. Chart 9 (bottom left). Foreign banks claims on Greece have fallen by approximately 225 billion euro since the onset of the sovereign debt crisis, cf. Chart 9 (bottom right). The main reason is that the volume of Greek sovereign debt has fallen, partly due to debt relief and partly due to branches and subsidiary banks in Greece having been discontinued or divested. Greek sovereign debt amounted to just under 18 per cent of GDP in 214. However, interest expenditure amounted to only just over 4 per cent of GDP, which is less than in Italy and Portugal, whose debts are lower, cf. Chart 1. This is because the international official lenders have supported Greece extensively by way of loans at low interest rates that are well below the market rates, i.e. the rates of interest charged by private sector investors lending money to Greece. The low rates of interest limit the increase in the debt and provide a basis for a period of moderate growth in GDP that can reduce the debt ratio considerably. 14 DANMARKS NATIONALBANK MONETARY REVIEW 1 ST QUARTER 215

15 Interest expenditure on the sovereign debts of selected countries Per cent Chart 1 Germany Spain Ireland Greece Italy Portugal Interest, per cent of GDP Interest, per cent of debt Note: Data for 214. Interest as a percentage of debt is calculated as interest expenditure relative to EMU debt the preceding year. Source: European Commission. FINANCIAL CONDITIONS On 22 January, the ECB announced that the existing asset purchase programme would be ex- panded, cf. above. The ECB also announced that interest rate conditions would be eased for the remaining six auctions in connection with targeted long-term refinancing operations, TLTROs. The fixed rate of interest on TLTRO loans is now simply the ECB s main refinancing rate, whereas previously a fixed spread of.1 percentage point applied. The expansion of the purchase programme and the amended TLTRO loan terms will both boost the ECB s balance sheet. On 15 January, Schweizerische Nationalbank, SNB, abandoned the minimum exchange rate of the Swiss franc vis-à-vis the euro. This announcement took the financial markets completely by surprise and the franc immediately strengthened notably, cf. Box 2. The SNB cited weakening of the franc against the dollar so that it was no longer massively overvalued as one of the reasons for its decision. On 12 February, Sveriges Riksbank announced that its repo rate would be reduced from per cent to -.1 per cent.1 Swedish banks can deposit excess liquidity in Riksbank certificates at a rate of interest that is identical to the repo rate. This Swiss monetary policy December 214 to January 215 Box 2 Continues next page From the onset of the financial crisis and until August 211, the Swiss franc strengthened by approximately 4 per cent, cf. the left-hand chart below. This led to marked deterioration of Switzerland s competitiveness and resultant fears of a recession and disinflation. In September 211, Schweizerische Nationalbank, SNB, therefore introduced a minimum exchange rate of 1.2 francs per euro as it assessed the franc to be massively overvalued. 1 Following the introduction of the minimum exchange rate, recurrent financial uncertainty has entailed that international investors have wished to hold Swiss francs. Consequently, the SNB has intervened for considerable amounts and the foreign exchange reserve has grown, cf. the right-hand chart below. In December 214 there was, once again, upward pressure on the Swiss franc. According to the SNB, this was to some extent attributable to increased uncertainty in the financial markets due to geopolitical turmoil. The foreign exchange reserve increased by 34 billion francs in December, and the SNB reduced the rate of interest on some deposits with the bank from. to -.25 per cent. 2 The pressure continued in early January, reflecting factors such as market expectations of quantitative easing on the part of the ECB. On 15 January 215, the minimum exchange rate vis-à-vis the euro was abandoned and the rate of interest on the banks marginal deposits reduced further, to -.75 per cent. The SNB cited weakening of the franc against the dollar so that it was no longer massively overvalued as one of the reasons for its decision. The governor of the SNB also pointed out that the minimum exchange rate had been introduced as an extraordinary and temporary measure to protect the Swiss economy. 3 On the day of the announcement, the franc briefly strengthened by approximately 3 per cent. By the end of the day, it had strengthened by approximately 15 per cent and traded at around 1 franc per euro. 1. Cf. statement by Philipp Hildebrand, Introduction of a minimum Swiss franc exchange rate against the euro, Schweizerische Nationalbank, 6 September The interest rate reduction took effect on 22 January and was therefore preceded by the reduction on 15 January. 3. Cf. Press Conference: Introductory Remarks by Thomas Jordan, Schweizerische Nationalbank, 15 January At the same time, the Riksbank announced purchases of government bonds with maturities of 1-5 years for a total of 1 billion Swedish kronor (.3 per cent of GDP). DANMARKS NATIONALBANK MONETARY REVIEW 1 ST QUARTER

16 Continued Box 2 Swiss franc (left) and foreign exchange reserve (right) Swiss francs per euro Index, January 25 = Swiss francs per euro (reverse scale) Minimum exchange rate relative to euro Effective Swiss franc (right-hand axis) Per cent of GDP Note: Right-hand chart: Foreign exchange reserve including gold. Source: Thomson Reuters Datastream and Swiss National Bank, SNB. makes the Riksbank the latest in a series of European central banks that have introduced negative deposit rates within the last couple of years, cf. Chart 11 (left). In several cases, lending rates have been reduced more or less in parallel with deposit rates, but remain in positive territory. In many European economies there is currently excess liquidity, which means that the monetary policy counterparties need to deposit liquidity with the central bank. Consequently, the central banks deposit rates govern money market interest rates. The reductions of the deposit rates have therefore caused money market rates to fall, cf. Chart 11 (right). Annual growth in lending by banks to non-financial corporations in the euro area has been negative since the spring of 212, cf. Chart 12. This reflects a combination of weak demand and tight Monetary policy interest rates (left) and 3-month money market interest rates (right) Chart 11 Per cent Apr 14 Jul 14 Oct 14 Jan 15 Denmark Sweden Euro area Switzerland Per cent Apr 14 Jul 14 Oct 14 Jan 15 Denmark Sweden Euro area Switzerland Note: Left-hand chart: The rate of interest on certificates of deposit is shown for Denmark, the repo rate/rate of interest on Riksbank certificates for Sweden, the deposit rate for the euro area and the Swiss Average Rate Overnight, SARON, for Switzerland. Right-hand chart: 3-month interest rate swaps. Source: Thomson Reuters Datastream and Reuters EcoWin. 16 DANMARKS NATIONALBANK MONETARY REVIEW 1 ST QUARTER 215

17 Credit conditions, demand for credit and lending growth in the euro area Net balances Chart 12 Per cent, year-on-year 2 Tightening of credit conditions, increased 15 demand for credit Credit conditions Demand for credit Lending to firms (right-hand axis) Note: Credit conditions and demand for credit according to the ECB s lending survey. Growth in total lending by banks to non-financial corporations. Source: Thomson Reuters Datastream. Rotation of voting rights in the ECB s Governing Council Box 3 The ECB s Governing Council comprises the six members of the ECB s Executive Board and the central bank governors of the euro area member states. As a main rule, the Governing Council makes decisions by a simple majority of votes, and if there is a parity of votes, the vote of the President is decisive. According to the Statute of the ECB, each member state has one vote until the number of national central bank governors exceeds 15. After that, they take turns to hold voting rights. However, the Governing Council has been empowered to postpone this decision until the number of national central bank governors exceeded 18. With Lithuania s membership of the euro area from 1 January, the number has now reached 19 and hence the rules on rotation of voting rights have come into force. The six members of the ECB s Executive Board still have one vote each. The national central bank governors are divided into two groups using a special distribution key. 1 The first group, comprising the five national central bank governors of Germany, Spain, France, Italy and the Netherlands, shares four voting rights. The second group, comprising the remaining 14 central bank governors, shares 11 voting rights. The voting rights rotate on a monthly basis, and within each group the central bank governors have voting rights for equal periods of time. All members of the Governing Council may still attend all meetings with full rights to speak. 1. The ranking of the national central banks is based on the size of the member states (a) share of the aggregate GDP at market prices and (b) share of the total aggregated balance sheet of monetary financial institutions, MFIs. The GDP share is assigned a weight of 5/6, while the MFI balance sheet share is assigned a weight of 1/6. credit conditions. However, bank lending rates fell in the course of 214, although the spreads to monetary policy interest rates remain wider than before the financial crisis in several euro area member states. The ECB s lending survey also shows that credit conditions have been eased for three quarters running and that firms demand for credit has increased. All this points to a more positive development in credit in future. This view is also supported by marginally positive monthly growth in lending by banks to non-financial corporations in December and January; growth had been negative throughout virtually all of 214. On 1 January, Lithuania joined the euro area as member state number 19. As a result, the rules on rotation of voting rights in the Governing Council of the ECB have entered into force, cf. Box 3. FOLLOW-UP OF RECOMMENDATIONS UNDER THE STABILITY AND GROWTH PACT At present, 11 EU member states have received recommendations under the Stability and Growth Pact to reduce their government deficits to below 3 per cent of GDP by a given deadline and to tighten their public finances. However, several member states have been struggling to meet their deadlines, partly because the economy has developed less favourably than assumed when the recommendations were made. As a main rule, the Stability and Growth Pact permits extension of the deadline by one year, but if the economy is very weak, it may be extended for several years. On 1 March, the ECOFIN Council decided to extend the deadline for France by two years, to 217. MONETARY AND EXCHANGE RATE CONDITIONS In recent months, the krone has been stable vis-àvis the euro, cf. Chart 13 (left). Demand for Danish kroner rose sharply from mid-january and was considerable until 2 February. This followed the announcement on 15 January by Schweizerische Nationalbank, SNB, that it would abandon the minimum exchange rate of the Swiss franc vis-à-vis the euro. The minimum exchange rate had been introduced in September 211, cf. Box 2. One week later, on 22 January, the ECB announced that the existing purchase programme would be expanded with significant purchases of government DANMARKS NATIONALBANK MONETARY REVIEW 1 ST QUARTER

18 Exchange rate of the krone via-à-vis the euro and Danmarks Nationalbank s rate of interest on certificates of deposit Chart 13 Exchange rate of the krone vis-à-vis the euro Kroner per euro Market rate Central rate Fluctuation limits (+/ per cent) Krone rate exchange rate and rate of interest on certificates of deposit Kroner per 1 euro Per cent Nov 14 Dec 14 Jan 15 Feb 15 Mar 15 Exchange rate of the krone vis-a-vis the euro Danmarks Nationalbank's rate of interest on certificates of deposit (right-hand axis) Note: Reverse scale for the exchange rate of the krone. The vertical lines indicate 15 January, when the SNB abandoned the minimum rate of the Swiss franc against the euro, and 22 January, when the ECB announced the expansion of its asset purchase programme. Changes in the rate of interest on certificates of deposit are shown on the day of the announcement. The most recent observations are from 1 March 215. Source: Danmarks Nationalbank. bonds. The measures taken by the ECB were more extensive than expected in the markets, especially since the purchases include securities with maturities of up to 3 years and because the purchase amounts are large and the programme period long, cf. the section on the international economy. The SNB s and the ECB s announcements both led to increased demand for kroner and a tendency for the krone to strengthen against the euro. The effect of the ECB s announcement was countered by Danmarks Nationalbank s announcement, on the same day, of an interest rate reduction, cf. Chart 13 (right). In order to stabilise the exchange rate of the krone, Danmarks Nationalbank intervened in the foreign exchange market, selling kroner against foreign exchange for considerable amounts. In January and February, Danmarks Nationalbank s interventions totalled kr and billion, respectively. Unlike in a situation with currency outflows and downward pressure on the krone, Danmarks Nationalbank has scope for unlimited intervention when the krone is strengthening. There is no upper limit to the size of the foreign exchange reserve. Danmarks Nationalbank unilaterally reduced its monetary policy interest rates on four occasions in January and February, cf. Table 2. Effective 2 January, the lending rate and the rate of interest on certificates of deposit were reduced by.15 percentage point to.5 and -.2 per cent, respectively. Effective 23 and 3 January the rate of interest on certificates of deposit was reduced by.15 percentage point on each occasion, to -.5 per cent, and finally the rate of interest on certificates of deposit was reduced by.25 percentage point to -.75 per cent effective 6 February. Also with a view to limiting the capital inflow into Denmark and hence the strengthening of the krone, the Ministry of Finance, at the recommendation of Danmarks Nationalbank, decided to suspend issuance of Danish government bonds from 3 January. This will reduce the supply of government bonds, thereby pushing down yields. It has the same effect as quantitative easing, which works by boosting demand. Furthermore, no T-bills were sold in the auctions on 11 February, 26 February and 11 March despite bids of kr. 5.9, 11.7 and 9. billion, respectively. Demand for kroner subsided on 2 February, and the krone weakened against the euro to a level closer to its central rate. Short-term Danish money market interest rates fell as Danmarks Nationalbank reduced interest rates. In early February, following the third reduction, and in mid-february, following the fourth reduction, the 1-month CITA swap rate was lower than the rate of interest on certificates of deposit. 18 DANMARKS NATIONALBANK MONETARY REVIEW 1 ST QUARTER 215

19 Danmarks Nationalbank s monetary policy interest rates Table 2 Rate of interest on certificates of deposit Lending rate Current account rate Discount rate End With effect from: 2 January January January February Source: Danmarks Nationalbank. This indicated that the markets expected monetary policy interest rates to be reduced further. The CITA swap rate rose by just over.1 percentage point on 13 February, to more or less the same level as the rate of interest on certificates of deposit. This indicated that the markets had expected Danmarks Nationalbank to reduce the rate of interest on the preceding day. Short-term money market interest rates rose further after 2 February, as the pressure on the krone eased. As short-term euro area money market interest rates were virtually unchanged from January to mid-march, a considerable decrease into negative territory of the spread between Denmark and the euro area was seen until mid-february, after which it rose again, to just above the monetary policy spread, cf. Chart 14. Interest rate spreads between Denmark and the euro area Chart 14 Percentage points.2. Suspension of issuance of government bonds SNB abandons minimum exchange rate ECB announces purchases Nov 14 Dec 14 Jan 15 Feb 15 Mar 15 Monetary policy interest rates FX swaps Interest rate swaps Note: The monetary policy spread is the spread between Danmarks Nationalbank s rate of interest on certificates of deposit and the ECB s deposit rate. The interest rate swap spread is the spread between the 3-month EONIA and CITA swap rates. The FX swap spread is the 3-month interest rate spread implied from FX swaps and is an expression of the costs of borrowing kroner against euro as collateral. The most recent observations are from 1 March 215. Source: Nordea Analytics, Thomson Reuters Datastream, ECB and Danmarks Nationalbank. DANMARKS NATIONALBANK MONETARY REVIEW 1 ST QUARTER

20 The implied interest rate spread between kroner and euro based on FX swaps widened notably from mid-january to mid-february, cf. Chart 14. This indicates that the forward price for kroner against euro rose. This should be viewed in the light of the decision by Schweizerische Nationalbank, SNB, to abandon the minimum exchange rate of the Swiss franc against the euro and the subsequent appreciation of the franc. These two factors caused some foreign investors to speculate in the idea of Danmarks Nationalbank abandoning the fixed exchange rate policy vis-à-vis the euro. Furthermore, Danish insurance and pension companies (the ICPF sector) to some extent wished to hedge the risk of appreciation of the krone. Instead of selling existing foreign exchange assets and purchasing krone-denominated assets, the ICPF sector hedged by forward purchases of Danish kroner. Demand for kroner in forward contracts put the price under pressure and widened the implied interest rate spread between kroner and euro based on FX swaps, cf. the article The Danish Krone under Pressure in January-February 215 in this Monetary Review. The FX swap spread narrowed after 2 February, when the currency inflow lessened. Danmarks Nationalbank s interventions have increased the volume of krone liquidity. Hence there is no longer any immediate need for Danmarks Nationalbank to conduct liquidity-adjusting operations with a view to providing liquidity as announced in mid-december 214. DEVELOPMENTS IN THE CAPITAL MARKET The yields on Danish government bonds fell sharply after the announcement of the suspension of issuance on 3 January, cf. Chart 15 (left). Before that, yields had already declined a little especially at the short end of the curve. This should be viewed against the background of market expectations that the level of Danish interest rates would soon rise again. The falls were related to the development in the Swiss franc, the ECB s announced expansion of its asset purchase programme and Danmarks Nationalbank s interest rate reductions. Despite the three unilateral Danish interest rate reductions, the spread between longer-term Danish and German government bond yields was marginally positive until the announcement of the suspension of issuance. Following the announcement, the spread narrowed for all maturities, cf. Chart 15 (right). From mid-february, when the currency inflow lessened, Danish government bond yields rose. In early March, the spread between 1-year Danish and German yields was around percentage points. Yields on mortgage bonds also fell significantly from January until mid-february. Especially the announcement of the suspension of issuance of government bonds had an effect on demand for Government bond yields and yield curves Chart 15 Danish government bonds Per cent Jan 14 Feb 14 Mar 14 Apr 14 May 14 Jun 14 Jul 14 Aug 14 Sep 14 Oct 14 Nov 14 Dec 14 Jan 15 Feb 15 Mar 15 2-year 5-year 1-year 3-year Yield curves for Denmark and Germany Per cent Denmark, 29 Jan. Denmark, 3 Feb. Germany, 29 Jan. Germany, 3 Feb. Note: Left-hand chart: Par yields, i.e. calculated yields for remaining maturities of exactly 2, 5, 1 and 3 years. The most recent observations for the left-hand chart are from 1 March 215. Source: Nordea Analytics and Danmarks Nationalbank. 2 DANMARKS NATIONALBANK MONETARY REVIEW 1 ST QUARTER 215

21 Mortgage yields Chart 16 Per cent Jan 1 Jul 1 Jan 11 Jul 11 Jan 12 Jul 12 Jan 13 Jul 13 Jan 14 Jul 14 Jan 15 1-year 3-year 5-year 3-year Note: The 1-, 3- and 5-year mortgage yields are based on fixed bullets. The 3-year yield is an average yield to maturity based on fixed rate callable mortgage bonds. Weekly data. The most recent observations are from calendar week 11, 215 for the 1-, 3- and 5-year yields and calendar week 1, 215 for the 3-year yield. Source: Association of Danish Mortgage Banks and Nordea Analytics. mortgage bonds. The yield on 1-year fixed bullets for financing adjustable rate loans became negative at the end of January, as did the 3-year yield in early February. Towards the end of February, mortgage yields rose a little again, cf. Chart 16. When yields on short-term fixed bullets became negative, Nykredit and Nordea Kredit stopped issuing the underlying loan types, while the other mortgage banks still offered adjustable rate loans with short fixed interest periods. The negative yield is settled only between the mortgage banks and investors, via the price. Administration margins and brokerage fees mean that borrowers must still pay for their loans. Variable rate mortgage bonds are characterised by a coupon rate that is the sum of a reference interest rate (e.g. the CITA swap rate) and a spread. If the reference interest rate is sufficiently negative, it is therefore possible to have a negative coupon rate on the bond so that investors must make interest payments to borrowers. For fixed bullets, the coupon is fixed ahead of the refinancing auctions. It is not necessary for the coupon to be negative in order for the yield to maturity on a fixed bullet to become negative this could also be the case if, say, the coupon is set at and the bond is traded at a price exceeding par. Since the mortgage banks existing contracts have different approaches to the possibility of negative yields, it is difficult to gain a comprehensive overview of the challenges. But it has turned out that there are a number of system-related problems linked to negative coupons with reverse payment flows, i.e. investors paying and borrowers receiving interest. For example, the systems have been designed with a view to bond investors receiving interest payments from the issuer and hence there has not been any need for the issuer to know the identity of the bond owner. There has also been uncertainty in relation to the tax treatment of negative interest, but it has now been established that negative interest should, in principle, be treated in the same way as positive interest. So any interest payable by bond investors will be deductible, and likewise borrowers must pay tax on any interest received. Although negative yields are still expected to be exceptions in the future, it is important that each mortgage bank finds a robust solution to prevent uncertainty about the handling of negative yields. DANMARKS NATIONALBANK MONETARY REVIEW 1 ST QUARTER