World Watches as Danes Venture Below Zero

Of all the many striking policy measures taken since the financial crisis, one of the most extraordinary has gone almost unremarked—the introduction of negative official interest rates by Denmark.

Danish Kroner
Chris Radcliffe | Bloomberg | Getty Images
Danish Kroner

In an attempt to maintain its strict currency peg to the euro, the Danish central bank lowered its main deposit rate for banks—the certificate of deposit or CD rate—to -0.2 percent last month.

The Nationalbanken felt it had little choice. Investors flocked to Denmark in search of a haven outside the euro zone—one that has no currency risk with the euro and offers cheap protection against a break-up of the single currency.

The move to negative rates is being watched closely by central banks around the world. “We have never been so popular,” laughs one Danish policy maker.

Apart from a brief move by Sweden in 2009-10, negative official rates are something of a novelty. But others may soon follow suit, with the European Central Bank (CNBC Explains: What Is the ECB?) recently cutting its deposit rate to zero and warning that it could go negative.

Policy makers in the UK and elsewhere in Europe have expressed interest in the idea as a potential way of forcing banks that are currently hoarding cash to start lending again.

“The Danish central bank is the first one in a small experiment of what happens when you impose negative interest rates,” says Thomas Kressin, head of the European foreign exchange desk at Pimco, one of the world’s largest bond investors.

“The popularity of the Danish krone is because of the unpopularity of the euro. Investors all over the world are looking for safe investments and are even willing to face negative interest rates for the security of knowing their money will still be there.”

So far, the economic impact of the move is largely unknown. Scandinavians take their summer holidays in July, so the central bank has little normal data to rely on. But officials acknowledge there has been a negative impact on banks, which they estimate to amount to about DKr300 million ($50.5 million).

Danish banks have about DKr200 billion on deposit at the central bank. While Nationalbanken has increased the amount banks can hold on current account—where the interest rate is zero—from DKr23 billion to DKr70 billion, this still leaves a sizeable chunk where banks will, in effect, have to pay the central bank to look after their money.

Bank executives, as well as central bankers, are clear that lenders have to increase their loan prices to compensate for the loss, as they are unable to impose negative rates on customers.

“When we are at zero [for customers’ deposits], we can’t go any lower. We have to recover that money in other ways, so we do that by increasing our margins on loans,” Eivind Kolding, chief executive of Danske Bank, the country’s biggest lender, said this month.

Government bond yieldshave followed suit, complicating a normal way for banks to make money. Denmark’s two-year bond yields, which had never previously been negative, were -0.22 percent on Thursday.

The danger is that this hurts the economy by reducing lending. But, in Denmark, this has been offset by a huge fall in mortgage rates as the official lending figure—the central bank’s headline interest rate—has also dropped, although it remains just in positive territory at 0.2 percent.

One-year mortgage bonds being auctioned this month are expected to yield only about 0.25 percent, according to analysts, down from the 1 percent they fetched last year.

Mr. Kolding notes that, for consumers, the cost of a mortgage in Denmark is exceptionally low. But outsiders still think the overall impact on the economy is more negative than positive.

“It is almost quantum physics,” says Mr. Kressin. “All the way down to zero, monetary policy is ultra loose. But below zero, to some extent you tighten policy, because you impose a cost on the banking system.”

Nationalbanken officials are also keeping a close eye on the circulation of coins and notes. So far, as commercial banks still offer zero for current accounts rather than negative rates, there has been no move from the public to hoard cash. But central bankers concede that if the CD rate fell to, say, -1 percent, banks might feel under more pressure to charge customers.

Denmark’s fierce defense of its currency peg means that a further move into negative territory cannot be ruled out, especially if the ECB were to cut rates further. But the small relative size of the Danish economy and the existence of the peg have led some to question how much other central banks can learn from its experiment.

“Can the ECB draw any lessons? It’s too much of a stretch from my perspective,” says Mr. Kressin.