Monetary and
Exchange-Rate Policy
In 2004 the krone was stable against the euro at a level slightly strong-er than the central rate. It was possible to stabilise the krone with limited intervention in terms of both amounts and number of interven-tions.
In June 2004, Estonia, Lithuania and Slovenia joined ERM II as part of their preparations for euro area membership. The inclusion of the new currencies does not entail any changes in the terms for the Danish krone in ERM II.
Danmarks Nationalbank has held its interest rates unchanged since June 2003 when the ECB lowered its interest rate. The lending rate and the rate of interest for certificates of deposit were then reduced to 2.15 per cent.
The foreign-exchange reserve was reduced by kr. 6 billion in 2004 due to sale of foreign exchange by Danmarks Nationalbank.
THE FIXED-EXCHANGE-RATE POLICY
The objective of Denmark's monetary and foreign-exchange policy is to keep the krone stable against the euro. Normally the Danish monetary-policy interest rates follow those of the ECB, so that a constant interest-rate spread is maintained. If there is a more prolonged tendency for the krone to strengthen or weaken, Danmarks Nationalbank unilaterally adjusts its monetary-policy interest rates. Danmarks Nationalbank can also intervene in the foreign-exchange market to stabilise the exchange rate.
Since 1999 Denmark's fixed-exchange-rate policy has been conducted within the framework of the European exchange-rate mechanism, ERM II. ERM II stipulates a fluctuation band for the participating currencies vis-à-vis the euro of +/- 15 per cent around the central rate. As a consequence of Denmark's stability-oriented economic policies and the high degree of economic convergence with the euro area, a narrower fluctuation band has been agreed, whereby the krone may fluctuate by +/- 2.25 per cent around the central rate of kr. 746.038 per 100 euro. Stability-oriented economic policies are thus a precondition for the fixed-exchange-rate system. For a number of years the krone has been close to its central rate, and usually slightly stronger, cf. Chart 8.
| KRONE VIS-À-VIS EURO |
Chart 8
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| Note: Daily observations. | |
| Source: Danmarks Nationalbank. | |
On 1 May 2004, 10 new countries joined the EU, and on 28 June 2004 Estonia, Lithuania and Slovenia joined ERM II as part of their preparations for euro area membership, cf. p. 76.
The inclusion of the new currencies does not entail any changes in the terms for the Danish krone in ERM II. The euro is at the core of ERM II. The participating currencies have central rates vis-à-vis the euro, but not in relation to each other. The obligation to intervene if a participating currency reaches one of its fluctuation margins rests solely on the central bank of the relevant member state and the ECB.
The fixed-exchange-rate system must build confidence and support economic convergence. Thus, it is important that the new EU member states adjust their economic policies prior to participation in ERM II to bring them in line with the requirements of the fixed-exchange-rate policy.
The operational procedures for ERM II are stated in the central-bank agreement from 1998 between the ECB and the central banks of the non-euro area member states. The agreement was amended slightly in September 2004. Danmarks Nationalbank and the central banks of the other ERM II member states must now no longer acquire the prior approval of the ECB before large interventions in euro, but must instead immediately notify the ECB.
THE ECB'S MONETARY POLICY
The primary objective of the ECB's monetary policy is to maintain price stability. In addition, the monetary policy is to support the general economic policies in the euro area, provided that this does not conflict with the primary objective. The ECB defines price stability as a year-on-year increase in the EU Harmonised Index of Consumer Prices, HICP, of below but close to 2 per cent in the medium term.
Monetary-policy decisions are based on extensive analyses that are structured within two pillars – economic analysis and monetary analysis. In the economic pillar, the ECB analyses a wide range of economic and financial indicators and the resulting risks to price stability in the short and medium term. The monetary pillar comprises an analysis of the development in a wide range of monetary indicators, including the money stock, with a view to assessing the inflation prospects in the medium to long term.
Monetary policy in 2004
Growth in economic activity in the euro area was subdued in 2004 and clearly declining over the year. At the beginning of 2004, the annual rate of increase in HICP in the euro area was just under 2 per cent, but then rose to just over 2 per cent, partly as a result of rising oil prices. Core inflation (calculated as HICP excluding energy, food, alcohol and tobacco) was stable on the low side of 2 per cent, and wage increases were subdued. The ECB assessed that inflation in the medium term would develop in accordance with the ECB's objective of price stability. Consequently, the ECB did not adjust its official interest rates in 2004. The minimum bid rate has thus been unchanged since June 2003, when it was lowered to 2 per cent.
The low level of interest rates has underpinned the growth in the monetary aggregate, M3, and in the credit institutions' lending to the private sector. Growth in lending was broadly based and accelerated in 2004. Growth in M3 in 2004 was lower than in the preceding year due to the tendency for a shift from short-term money-market holdings to holdings in longer-term financial assets outside M3.
Adjustment of the monetary-policy instruments
With effect from the refinancing operation on 9 March 2004, the ECB made a number of adjustments to its monetary-policy instruments, inter alia to limit the impact of interest-rate expectations on bidding behaviour in monetary-policy operations. Prior to the adjustments there were incidents where the banks, expecting that interest rates would be lowered, overall demanded less liquidity in the ECB's refinancing operations than necessary to meet the reserve requirement (underbidding). The adjustments in 2004 reduced the maturity of lending in the weekly refinancing operations from 14 to 7 days, and adjusted the reserve maintenance period to start on the settlement date of the first weekly tender after the monthly meeting of the Governing Council, at which the monetary-policy interest rates are discussed. Box 1 describes the ECB's monetary-policy instruments in more detail.
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Box 1
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The ECB's monetary-policy instruments comprise refinancing operations, reserve requirements and standing facilities. Refinancing operations are mainly conducted as weekly main refinancing operations, supplemented with long-term refinancing operations. In addition, fine-tuning operations may be conducted. In the weekly operations, banks in the euro area can raise seven-day loans against collateral. The operations are conducted as tenders whereby the banks submit bids for both the interest rate and the amount of liquidity required. The ECB has determined a minimum bid rate in advance. The ECB allots liquidity so that bids with the highest interest rates are complied with first. The marginal rate is the lowest rate at which liquidity is allotted, and pro-rata allotment may take place at the marginal rate. The marginal rate is normally close to the minimum bid rate, which is the ECB's signal rate. In the monthly long-term refinancing operations, loans with a maturity of three months are provided against collateral. The ECB conducts fine-tuning refinancing operations on an ad-hoc basis to manage liquidity conditions and interest rates, particularly with a view to smoothing the effect of unexpected liquidity fluctuations on interest rates. In connection with a fine-tuning operation at the end of 2004 the ECB announced that in future substantial imbalances in liquidity conditions that may cause significant volatility in the overnight interest rate, Eonia, will be addressed more effectively. This is particularly relevant if the liquidity requirement in the banking sector deviates substantially from the ECB's forecast at the end of the reserve requirement period. The reserve requirement entails that during the monthly reserve maintenance periods banks in the euro area must have a certain average deposit on their reserve accounts with the national central banks. The reserve requirement system stabilises the overnight interest rate since the counterparties have an incentive to lend liquidity in the market when the overnight interest rate exceeds the rate of interest on required reserves. On the other hand, the counterparties have an incentive to maintain ample reserves in the periods when the overnight interest rate is below the rate of interest on required reserves. The required reserves accrue interest at the average marginal rate in the period. The standing deposit and lending facilities give the banks access to deposit or borrow against collateral on a day-to-day basis. The rate of interest on the deposit and lending facilities are 1 per cent lower and 1 per cent higher, respectively, than the minimum bid rate. |
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| 1 The ECB's monetary policy and monetary-policy instruments are described in detail in ECB, The monetary policy of the ECB, January 2004. | |
The transition did not cause any problems, and the euro overnight interest rate (Eonia) remained close to the marginal rate after the transition. Brief fluctuations in Eonia are still seen in connection with the expiry of the reserve maintenance period, cf. Chart 9.[1]
| THE ECB'S INTEREST RATES AND THE OVERNIGHT INTEREST RATE IN THE EURO AREA |
Chart 9
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| Source: ECB. | |
Danmarks Nationalbank has held its interest rates unchanged since June 2003 when the ECB lowered its interest rate. The lending rate and the rate of interest for certificates of deposit were then lowered by 0.5 per cent to 2.15 per cent, cf. Chart 10. The current-account interest rate and the discount rate were likewise lowered by 0.5 per cent to 2 per cent.
| LENDING RATES OF THE ECB AND DANMARKS NATIONALBANK |
Chart 10
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| Note: Prior to 28 June 2000, the ECB's fixed allotment rate. | |
| Source: ECB and Danmarks Nationalbank. | |
The krone was stable against the euro in 2004 at a level slightly stronger than the central rate, cf. Chart 8. In the first months of 2004 the krone weakened marginally, and Danmarks Nationalbank sold foreign exchange for kroner in the foreign-exchange market. The weakening of the krone should be seen against the background of considerable net purchases of foreign securities by Danish investors, particularly pension funds.The krone subsequently strengthened towards the middle of 2004,
and Danmarks Nationalbank made net foreign-exchange purchases for small amounts. The strengthening of the krone took place at times of net foreign purchases of Danish bonds. There was by and large no intervention in the foreign-exchange market in the latter half of 2004.
In recent years it has been possible to stabilise the krone with limited intervention in terms of both amounts and number of interventions, cf. Table 3. Combined with the narrow interest-rate spread to the euro area, this confirms the credibility of the Danish fixed-exchange-rate policy and stable economic conditions. Participants in the foreign-exchange market take positions in the expectation of a stable krone, which in itself contributes to stable exchange-rate development. Interventions by Danmarks Nationalbank constitute only a very small proportion of the total turnover in the global foreign-exchange market in Danish kroner. The average daily turnover in the global krone market in April 2004 was around kr. 100 billion.
The monetary-policy instruments remained unchanged in 2004. However, use of euro-denominated government and mortgage-credit bonds as collateral for monetary-policy loans was introduced, cf. Box 2
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Box 2
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Danmarks Nationalbank makes two facilities available to the banks and mortgage-credit institutes that are monetary-policy counterparties. Firstly, on the last banking day of each week the counterparties can purchase certificates of deposit or borrow against collateral. These transactions normally have a maturity of 14 days, and the relevant interest rates, called respectively the rate of interest for certificates of deposit and the lending rate, are identical. In addition, Danmarks Nationalbank purchases or sells certificates of deposit when needed, e.g. in connection with fluctuations in central-government payments. Secondly, the counterparties can place funds as overnight current-account deposits. Current-account deposits accrue interest at the current-account interest rate, which is lower than the interest rate for certificates of deposit. There is a limit to the counterparties' total current-account deposits. Each counterparty has been allocated a proportion of the total current-account limit in accordance with its relative size and the level of activity in the money market. The total limit is around kr. 20 billion. If it is exceeded, each counterparty's current-account deposit exceeding the individual limit will be converted automatically to certificates of deposit. So far this has not been necessary since the overall limit has been respected. The discount rate is a signal rate indicating the overall level of the monetary-policy interest rates. Since 1992, when the key principles for the current monetary-policy instruments were introduced, the current-account interest rate has been identical to the discount rate. Amendment to the terms and conditions for pledging of collateral |
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| 1 For a more detailed description of the monetary- and foreign-exchange-policy instruments, see Danmarks Nationalbank, Monetary Policy in Denmark, 2003 and Danmarks Nationalbank's website www.nationalbanken.dk.2 Cf. Danmarks Nationalbank, New Terms and Conditions for Accounts, Danmarks Nationalbank, Monetary Review, 3rd Quarter 2004. | |
THE MONEY MARKET AND THE SHORT-TERM INTEREST RATES
In 2004 Danish money-market interest rates generally followed the development in euro-area money-market interest rates. At the close of the year, the Danish money-market interest rates were by and large at the same level as at the beginning of the year. While fluctuations in the short-term money-market interest rates in 2004 were limited, larger fluctuation was seen in the long-term money-market interest rates, e.g. as a result of shifting market expectations of the development in interest rates, cf. Chart 11. However, money-market interest rates declined up to the meeting of the Governing Council in April, and for a while the 12-month interest rate was below the 1-month interest rate in both the euro area and Denmark. This indicated market expectations that the ECB would lower its official interest rates.
| MONEY-MARKET INTEREST RATES IN DENMARK |
Chart 11
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| Note: Daily observations, Cibor rates. | |
| Source: Danmarks Nationalbank. | |
In 2004 the spread between money-market interest rates in Denmark and the euro area was generally slightly narrower than the spread between Danmarks Nationalbank's lending rate and the ECB's minimum bid rate of 15 basis points, cf. Chart 12. The spread was influenced by the fact that a large proportion of the banks in the euro area adjust their balance sheets at year-end. This is reflected in increases in the euro-area money-market interest rates from the day that maturities begin to stretch into the next year. For instance, the 1- and 2-month interest rates in the euro area rose respectively 1 and 2 months before the turn of the year, which narrowed the spread between interest rates in Denmark and the euro area. A similar impact on euro-area money-market interest rates was seen in preceding years. Immediately after the turn of the year the spread widened again, although it is still at a lower level than in 2004.
| INTEREST-RATE SPREAD TO THE EURO AREA IN THE MONEY MARKET |
Chart 12
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| Note: Daily observations. Spread between Cibor and Eurobor rates. | |
| Source: Danmarks Nationalbank. | |
A significant amount of the volatility in the Danish overnight interest rate is attributable to technical factors which typically cause the overnight interest rate to rise temporarily when Danmarks Nationalbank conducts monetary-policy operations.[2] Money-market participants understand the workings of the overnight market, and the volatility in the overnight rate does not affect the money-market interest rates with longer maturities, cf. Chart 13. Therefore, the volatility does not constitute a problem from a monetary-policy point of view..
| DANISH MONEY-MARKET INTEREST RATES WITH DIFFERENT MATURITIES |
Chart 13
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| Note: Daily observations. | |
| Source: Danmarks Nationalbank. | |
Cibor (Copenhagen Interbank Offered Rate) is a reference interest rate for uncollateralised krone-denominated lending in the inter-bank market. A number of banks report interest rates to Danmarks Nationalbank, which calculates and announces Cibor on a daily basis. The rates reported by the individual banks are published by the Danish Bankers Association. In April 2005 four foreign banks join the group of banks participating in the fixing of Cibor, bringing the total to 12 banks, and the number of maturities for which Cibor rates are fixed is raised by six to 14 maturities in all, cf. the press release "New Cibor participants" from the Danish Bankers Association, 7 January 2005. The reason for increasing the number of participants and quoted maturities is to ensure the continued credibility and recognition of Cibor.
The banks' interest rates and interest rates for short-term mortgage-credit loans
The banks' average lending rates fell by around 0.2 per cent during 2004, while the average deposit rates rose slightly. The development should be seen in the light of more widespread use of the banks' "mortgage" loans, cf. p. 51.
Interest rates for short-term mortgage-credit loans matched the development in the other money-market interest rates. According to the Association of Danish Mortgage Banks, the short-term mortgage rate was around 2.5 per cent at the end of the year.
CAPITAL FLOWS AND FOREIGN-EXCHANGE RESERVE
The current-account surplus was kr. 35 billion in 2004, while capital exports totalled kr. 41 billion, cf. Table 4. This was paralleled by Danmarks Nationalbank's sale of foreign exchange for kr. 6 billion. The foreign-exchange reserve thus decreased, and after value changes totalled kr. 218 billion at end-2004..
The capital exports consisted of net purchases of foreign bonds for kr. 105 billion, which is a continuation of the considerable net purchases in recent years. Net purchases of foreign shares amounted to kr. 43 billion, around twice the 2003 level. Net sales of Danish bonds contributed to capital imports of kr. 51 billion. Overall, portfolio investments entailed capital exports of kr. 88 billion.
[1] The widening of the spread between the marginal rate and the minimum bid rate since the transition is, according to the ECB, in accordance with a larger increase in the bid volume than in the allotted volume in the refinancing operations, cf. "Initial experience with the changes to the Eurosystem's operational framework for monetary policy implementation", ECB, Monthly Bulletin, February 2005.
[2] Cf. article by Allan Bødskov Andersen, Volatility in the Overnight Money-Market Rate, Danmarks Nationalbank, Monetary Review, 4th Quarter 2004.