Negative deposit rates The Danish experience

Transcription

1 Negative deposit rates The Danish experience Chief analyst Arne Lohmann Rasmussen FX, Rates and Commodities Research November 2013 Investment Research

2 Agenda the Danish experience Danish monetary policy an overview Monetary policy instruments in Denmark Why negative rates in Denmark Effect of negative rates on Danish financial assets and the economy What can ECB learn from Denmark 2

3 Danish monetary policy an overview 3

4 Denmark conducts a fixed-exchange-rate policy Denmark conducts a fixed-exchange-rate policy vis-à-vis the euro. Consequently, monetary and foreign-exchange policy is aimed at keeping the krone stable against the euro. Other considerations than the exchange rate are not considered in relation to monetary policy, and Danmarks Nationalbank's monetary-policy interest rates are used solely to manage the krone rate. The main objective of monetary policy in the euro area is to maintain an inflation rate of below, but close to, 2 per cent. By keeping the krone stable against the euro, a basis for low inflation is also created in Denmark in the slightly longer term. The formal framework for Denmark s fixed-exchange-rate policy is the European Exchange Rate Mechanism, ERM II. Denmark participates at a central rate of kroner per euro and a fluctuation band of +/ per cent. Formally, ERMII participation only implies that the krone must be kept within the fluctuation band, but since 1997 Danmarks Nationalbank has kept the krone close to its central rate. (Source: Monetary Policy in Denmark, Nationalbanken 2009) 4

5 Fixed-exchange-rate policy has been successful EUR/DKK Central parity EUR/DKK spot De-facto trading range Upper limit (+2.25%) Lower limit (-2.25%) Source: Reuters EcoWin 5

6 Monetary policy instruments in Denmark Danmarks Nationalbank conducts monetary policy via its monetary-policy instruments, i.e. the facilities used by Danmarks Nationalbank to manage and remunerate accounts (lending and deposits) with banks and mortgage Institutes the monetarypolicy counterparties. Lending rate (7-days lending rate): (0.20%) Certificates of Deposit rate (7-days deposit rate): (-0.10%) Current-account rate (limited) (overnight rate): (0.0%) 6 5 Lending rate 4 3 Certificates of Deposit rat 2 1 Current-account Source: Reuters EcoWin

7 Danish banks have a positive net position against the central bank equivalent to excess liquidity The net position is primarily affected by fluctuations in government payments and Danmarks Nationalbank's purchase and sale of foreign exchange. Hence, autonomous factors that the sector as a whole cannot change. 300 mia. kr Source: Nationalbanken Data from June Banks net position against Nationalbanken

8 Negative Interest Rate Police (NIRP)

9 Denmark as a test case: Practical challenges with negative deposit rates Change in consumer behaviour Currency depreciation Increased probability space for central bank behaviour Operational risks Negative deposit rates Costs for the banking sector and change in market behaviour Funding availability and money market functionality

10 Why did Denmark introduce negative rates in 2012?

11 1a) Investors had flocked to DKK bonds since 2010 Foreign investors now hold more than DKK230bn in Danish government bonds DKKbn Stock of government bonds held by foreigners Source: Nationalbanken Foreign investors hold around DKK34bn of Danish treasury bills DKKbn Stock of treasury bills held by foreigners Source: Nationalbanken...which is around 34% of the total stock % of total stock Stock of government bonds held by foreigners Source: Nationalbanken...which amounts to around 81% of the total stock % of total stock Stock of treasury bills held by foreigners Source: Nationalbanken Short-dated bonds and mortgage bonds and not least t-bill have been in strong demand from especially US accounts that can take advantage of access to cheap US dollars relative to kroner. (FX Swap) 11

12 1b) Investors had flocked to DKK bonds since 2010 Foreign investors hold around DKK585bn in Danish bonds Stock of DKK denom. bonds held by foreigners Source: Nationalbanken Foreign investors portfolio of Danish mortgage bonds now around DKK313bn DKKbn DKKbn Stock of DKK denom. mortgage bonds held by foreigners Source: Nationalbanken...which amounts to almost17% of the total stock % of total stock Stock of DKK denom. bonds held by foreigners Source: Nationalbanken...which is almost 12% of the entire stock % of total stock Stock of DKK denom. mortgage bonds held by foreigners Source: Nationalbanken 12

13 Why did investors go into Denmark? Strong fundamentals Sound public balances % of GDP % of GDP Budget balance % of GDP % of GDP Gross government debt EU-criteria EU-criteria Source: Reuters EcoWin Source: Reuters EcoWin Current account surplus Strong trade balance Source: Reuters EcoWin Source: Reuters EcoWin 13

14 Why did investors go to Denmark? other reasons Euro zone break-up fears. Safe-haven and diversification. Front-running of negative rates. Investors that believed that EUR/DKK would be allowed to move lower. Foreign investor increasingly focus on Danish mortgage bonds 14

15 2) The inflow pushed EUR/DKK lower Inflow Source: Macrobond Source: Macrobond and Danske Bank Markets Rate cut Source: Reuters EcoWin 15

16 3) It forced the central bank to intervene in the currency market If DKK tends to weaken or strengthen, Danmarks Nationalbank will normally respond first by intervening in FX markets. In the event of significant or continued impact on DKK, the central bank will normally supplement intervention by rate change. Source: Reuters EcoWin Danmarks Nationalbank will typically resort to rate change after FX intervention of DKK10-15bn. 16

17 4) Intervention started to become problematic as FX reserves increased significantly Source: Macrobond Source: Macrobond and Danske Bank Markets 17

18 5) The option of negative rates came on the table in the beginning of 2012 Few examples of negative rates. The Swedish Riksbank lowered the rate of interest on its deposit facility July But little market impact as very little cash was in fact deposited at a negative rate. In the 1970ties the interest rate for foreign deposits was negative in Switzerland, but not the monetary policy rate Negative market rates and yields have been more common. Danish and German t-bills traded with a negative yield as early as

19 6) What did the Danish monetary authorities consider 1. Needs to ensure a pass-through to the money market and the currency market 2. They wanted to use existing monetary-policy instruments and ease the strain on Danish banks 3. Focus on preparing the market for negative deposit rates 19

20 #1: Danish banks have a positive net position against the central bank => deposit rates are focal for market impact DKKbn The banks and mortgage-credit institutes net position with the Nationalbank Source: Nationalbanken 20

21 #1: Money market rates important for EUR/DKK Source: Reuters EcoWin falling carry-demand zero/negative carry debt crisis flow Negative deposit rate 21

22 #2 and #3: Use of exiting monetary-policy instruments When the CD rate was lowered to negative the currentaccount limits were hiked from DKK 23.14bn to DKK bn. (Banks can place at 0.0% at the current account) It reduces the strain on monetary-policy counterparties, but secures that the marginal deposit rates is still negative February 2012 was the financial sector informed directly about the possible use of negative rates (5 months notice) 22

23 The Danish monetary policy system after negative policy rates Source: Nationalbanken, Monetary Review Q

24 Effect of NIRP in Denmark EUR/DKK moved back towards the central parity The Danish central bank (Nationalbanken) cut its deposit rate (CD rate) to -0.2% on July 5 making Denmark the first country to truly introduce an official negative interest rate. Subsequently CD rate hiked to current level of -0.1%. The CD rate has been quite an effective tool to keep EUR/DKK close to the central parity EUR/DKK Source: Reuters EcoWin Deposit rates 6 % Aug Dec 11 Danish CB warns about possibility of negative rates EUR/DKK Apr Aug Dec 12 Denmark Eurozone Central parity Danish CB cut CD rate to -0.20% Apr Aug Source: Reuters EcoWin

25 NIRP: Turnover in overnight loans unaffected despite negative deposit rate Source: Naitonalbanken, Monetary Review Q

26 Market has underestimated for how long negative rates would last % % % % M CITA swap rate M T-Bill Current-accoutn rate Leding rate M CITA Swap rate Rate on certificates of deposits Jan May Sep Jan 10 May Sep Jan 11 May Sep Jan 12 May Sep 13 Jan May Sep Jan 10 May Sep Jan 11 May Sep Jan 12 May Sep 13 Source: Reuters Ecowin Source: Reuters Ecowin Market has underestimated how resilient Denmark and DKK has been to negative rates Rates market still look for a normalisation in Denmark Source: Danske Bank Markets 26

27 NIRP: Strong performance for short-dated bonds T-bill trading with negative yields 1y ARM s trading with a record low yield, % % % M T-Bill M CITA Swap rate Jan May Sep Jan 10 May Sep Jan 11 May Sep Jan 12 May Sep Source: Nationalbanken Source: Reuters EcoWin 27

28 But it has not kick-started the Danish economy Danish economy has not recovered Danish housing market is still quite weak 110 GDP q4 = Sweden Norway Finland Index 2005 =100, House prices Sweden Denmark Norway Finland Denmark UK Source: Reuters EcoWin Money supply is modest Source: Reuters EcoWin Source: Reuters EcoWin And money supply is in fact falling % y/y DKKbn 20 M2 money supply Source: Nationalbanken M2-velocity Source: 02 Nationalbanken

29 What can ECB learn from Denmark? any unintended consequences? Technically is possible. But some preparation time is warranted. Strong performance for short-dated bonds. Market pricing is affected. The Danish central bank did not cut rates to stimulate the economy, but to safe-guard the fixedexchange rate policy. The Danish central bank has ruled out a negative lending rate Small effect on the Danish economy that is still struggling. No magic bullet! Negative deposit rates comes with a cost for banks as corporates/households have not been charged. Bank lending rates might be hiked to compensate. (an unintended consequence) Danish banks can only to a limited degree affect excess liquidity (banks net position). Denmark introduced negative deposit rates in 2012 might worth hearing about their experiences and if they have seen any unintended consequences before I go down that road!

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