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"Report and Accounts 1999"

 

Monetary and Exchange-Rate Policy

Denmark's fixed-exchange-rate policy was maintained after the introduction of the euro. In continuation of the previous linking to the D-mark and the other core currencies in the European Monetary System, EMS, the krone is now linked to the euro at a central rate equivalent to the previous central rate vis-à-vis the D-mark. The formal framework is the exchange-rate mechanism, ERM II, which succeeded the EMS on the introduction of the euro in 1999. The krone's fluctuation band within ERM II is +/- 2.25 per cent.

The krone was very stable against the euro in 1999. The foreign-exchange reserve increased by kr. 64 billion. Against the background of the inflow of foreign exchange the Nationalbank lowered its official interest rates in several small steps during the 1st half of 1999. Furthermore, in April 1999 the Nationalbank lowered its interest rates in connection with a reduction of interest rates in the euro area. In November 1999 and February 2000 the Nationalbank increased its interest rates after rates in the euro area were raised. The short-term interest-rate differential to the euro area narrowed in 1999.

With effect from 21 June 1999 the Nationalbank's monetary-policy instruments were adjusted in a number of areas. These were primarily technical adjustments which did not affect the overall framework for the conduct of monetary policy.

The Foreign-Exchange-Policy Objective

The objective of Denmark's foreign exchange policy is to maintain a stable krone rate against the euro. The formal framework for Denmark's fixed-exchange-rate policy is the exchange-rate mechanism, ERM II, which succeeded the cooperation within the European Monetary System, EMS, on the introduction of the euro on 1 January 1999. In accordance with the agreement with the euro area member states and the European Central Bank, ECB, Denmark participates in ERM II with a central rate of kr. 746.038 per 100 euro and a fluctuation band of +/- 2.25 per cent. The central rate of the krone against the euro corresponds to its previous central rate vis-à-vis the D-mark. The linking to the euro is a continuation of the fixed-exchange-rate policy up to the introduction of the euro whereby the krone was linked to the D-mark and the other core EMS currencies.

In recent years the Nationalbank has stabilised the krone rate close to the central rate against the D-mark, and now the euro. Underlying trends for fluctuations in the krone rate are countered by purchasing or selling foreign exchange and/or adjusting the Nationalbank's interest rates.

The primary objective of the single monetary policy in the euro area is to maintain price stability. The linking of the krone to the euro therefore creates a framework for price stability in Denmark. The fixed-exchange-rate policy entails a clear dividing line between monetary and fiscal policy. The monetary policy is designed to maintain a stable krone rate against the euro and is therefore closely matched to the monetary policy of the euro area. It is the task of fiscal policy and other economic policy to manage domestic demand and to ensure that the course of the economy is compatible with the requirements of the fixed-exchange-rate policy.

The Monetary Policy of the Euro Area

The practical changeover to the euro was unproblematic and trading in the new currency began on 4 January 1999 when the currency markets opened after the New Year. The euro was introduced after the irrevocable fixing of the exchange rates of the 11 member states at conversion rates based on the previous EMS central rates. At the same time the introduction of the euro represented a transition to a single monetary policy and a single money market for the entire euro area.

The ECB's primary objective is to maintain price stability as defined by the ECB as a year-on-year increase in consumer prices of below 2 per cent. Price stability is to be maintained over the medium term. To meet this objective the ECB has adopted a monetary-policy strategy based on two pillars. The first is a reference value for growth in the broad monetary aggregate, M3, while the second pillar is an assessment of the development in other key financial and economic indicators of significance to price development. The reference value for the year-on-year growth in M3 which is found to be compatible with price stability in the medium term was set at 4½ per cent for 1999. The reference value is maintained in 2000.

If there is no threat to price stability in the euro area the ECB's mandate provides for the use of monetary policy to contribute to the utilisation of the growth potential of the euro area. In the spring of 1999 the annual rate of increase in consumer prices was approximately 1 per cent in the euro area, and the cyclical position implied a favourable outlook for price stability. Against the background of the modest inflationary pressure the Governing Council of the ECB on 8 April 1999 decided to lower the rate of interest for the main refinancing operations by 0.5 per cent to 2.5 per cent, cf. Chart 9. At the same time the rates of interest for the marginal lending facility and the deposit facility were also lowered by respectively 1 per cent and 0.5 per cent. In normal circumstances these two standing facilities constitute the interest-rate corridor for fluctuations in the overnight inter-bank rate of interest EONIA ^[1], cf. Box 1. The interest-rate adjustment narrowed the interest-rate corridor which was then symmetrical around the rate of interest for the main refinancing operations. With effect from the beginning of January 1999 the ECB had stipulated a relatively narrow interest-rate corridor of 0.5 per cent to make it easier for the market participants to adjust to the new money market in the euro area.

Chart 9 Official Interest Rates and Short-term Money-market Interest Rates in the Euro Area, 1999 and 2000

Note:

See the footnote for a description of the EONIA interest rate.

Box 1 The ECB's Main Refinancing Operations and the Minimum Reserve Requirement in Practice

During the summer and autumn of 1999 there were clear indications of an upswing in the euro area, and in the autumn growth in M3 edged upwards away from the reference value. In view of the increasing threats to price stability, on 4 November the ECB decided to raise the official interest rates by 0.5 per cent. Continued strong growth in M3 and an increasing risk of future inflation due to such factors as the euro's weakening induced the ECB to raise the official interest rates by 0.25 per cent on 3 February 2000. This brought the rate of interest for the main refinancing operations to 3.25 per cent with effect from 9 February.

In 1999 the ECB applied its monetary-policy instruments without recourse to extraordinary fine-tuning operations. Such operations can be used to smooth out unexpected liquidity fluctuations. The ECB carried out the first extraordinary fine-tuning operation on 5 January 2000 to absorb a proportion of the ample liquidity in the money market at the turn of the year.

Interest Rates in Denmark

During 1999 the krone was very stable vis-à-vis the euro at a level slightly above the central rate of the ERM II agreement. The first six months saw an underlying trend for a strengthening of the krone and the Nationalbank intervened by buying foreign exchange in the market, cf. Chart 10. On the basis of a considerable inflow of foreign exchange and a strong krone rate the Nationalbank lowered the rate of interest for certificates of deposit and the lending rate with effect from 7 January, 4 February and 1 March 1999 by a total of 0.55 per cent to 3.4 per cent, cf. Chart 11. When interest rates were reduced in February the discount rate was also cut by 0.25 per cent to 3.25 per cent. After the interest-rate reductions at the beginning of 1999 the spread between the short-term money-market rates in Denmark and in the euro area had narrowed to approximately 0.4 per cent after having widened to more than 3 per cent during the unrest on the financial markets in the autumn of 1998. The spread between short-term money-market rates in Denmark and in the euro area was relatively stable for the rest of 1999 and was around 0.4 per cent at the close of February 2000.

Chart 10 The Nationalbank's Net Purchases of Foreign Exchange and the Krone Rate Against the Euro

Note:

Weekly observations. The exchange rates vis-à-vis the D-mark are converted to exchange rates vis-à-vis the euro at the official conversion rate as at 31 December 1999.

Chart 11 Official Interest Rates and 3-month Inter-bank Interest Rate in Denmark

Against the background of the ECB's lowering of interest rates by 0.5 per cent on 8 April 1999 the Nationalbank equivalently reduced the official interest rates with effect from 9 April. This brought the discount rate down to 2.75 per cent, the lowest since 1933. The krone continued its slightly rising trend and after a considerable inflow of foreign exchange in the first half of June the Nationalbank on 17 June cut the rate of interest for certificates of deposit and the lending rate by 0.05 per cent to 2.85 per cent. This brought an end to the tendency towards an inflow of foreign exchange.

In the light of the ECB's decision on 4 November to raise the official interest rates by 0.5 per cent to redress the easing of interest rates in the spring, with effect from 5 November the Nationalbank raised the discount rate by 0.25 per cent to 3 per cent and the rate of interest for certificates of deposit and the lending rate by 0.45 per cent to 3.30 per cent. This narrowed the spread between the Nationalbank's lending rate and the ECB's rate of interest for main refinancing operations to 0.3 per cent. In view of the ECB's raising of the official interest rates by 0.25 per cent on 3 February 2000 the Nationalbank raised the discount rate by 0.25 per cent to 3.25 per cent and the rate of interest for certificates of deposit and the lending rate by 0.3 per cent to 3.60 per cent, with effect from 4 February. The outflow of foreign exchange of kr. 12 billion in January 2000 thus led to a slight widening of the spread between the Nationalbank's lending rate and the ECB's rate of interest for main refinancing operations.

In the 2nd half of 1999 the interest rates for money-market transactions with a maturity date after the millennium rollover were somewhat higher than the rates of interest for transactions expiring before the end of the year, cf. Chart 12. This pattern was also seen in money markets in other countries, primarily reflecting a premium on liquidity traded in the money market around the turn of the year. An interest premium in connection with money-market transactions around year-end is normal. The volume of transactions is low since the banks are closing their books and therefore seek to avoid positions which may affect the financial result for the year. However, the premium at the turn of the century was higher than in the preceding years due to concern about IT-related problems at the millennium change. Like most other central banks the Nationalbank had taken precautions in order to accommodate a possible surge in liquidity demand around the turn of the year. The Nationalbank gave access to both purchase and sale of certificates of deposit on 30 December 1999 and 3 January 2000. On the last days of the old year and on 3 January 2000 there were net sales of certificates of deposit from the Nationalbank to the banks and mortgage-credit institutes. However, the net sales on 3 January 2000 can be attributed primarily to a significant liquidity effect from central-government payments. Turnover in the money market was low on the days around the turn of the year, but generally the millennium rollover progressed smoothly and in January the yield curve of the money market had regained normal shape. After official interest rates were raised in November 1999 and February 2000 the yield curve is now at a higher level than the curve in July 1999. It is also slightly steeper, indicating that the market participants expect official interest rates to be raised further in 2000.

Chart 12 The Yield Curve in the Money Market in Denmark

Note:

Cibor rates, mid-month. The 7, 8 10 and 11 month rates are calculated by linear interpolation.

In 1999 the banks' average deposit and lending rates continued the declining trend of recent years. From the 4th quarter of 1998 to the 3rd quarter of 1999 the banks' average deposit rate fell by 1.2 per cent to 2.2 per cent, while the average lending rate decreased by 1.4 per cent to 6.9 per cent. The interest margin thus narrowed slightly. The decline in interest rates was reversed in the 4th quarter of 1999 when most banks increased their deposit and lending rates after the Nationalbank's raising of interest rates in November.

Bond yields
Bond yields rose considerably abroad and in Denmark during 1999 as global economic growth gained momentum. The higher yields also reflected a certain normalisation after the flight to safety in government bonds during the unrest on the financial markets in the autumn of 1998. The yield to maturity on Danish 10-year government bonds rose from a historically low level of approximately 4 per cent in January 1999 to almost 6 per cent in January 2000. The yield curve steepened considerably as bond yields rose, cf. Chart 13. The yield differential between Danish and German 10-year government bonds was very stable at around 0.5 per cent in 1999. The yield differential narrowed a little towards the end of the year. In February 2000 the yield differential was around 0.35 per cent.

Chart 13 Term Structure of Interest Rates in the Bond Markets, Zero-Coupon Rates

Note:

A zero-coupon rate is the yield to maturity of a bond with one payment only. The zero-coupon rate is an unequivocal measure of the yield on the individual maturities. Generally zero-coupon rates cannot be observed but must be estimated.

Yields on mortgage-credit bonds
The rising government-bond yields in 1999 had an impact on the Danish mortgage-credit market, cf. Chart 14. The differential between the average yield on a 30-year mortgage-credit bond and a 10-year government bond continued to be slightly higher in 1999 than before the financial-market unrest in the autumn of 1998.

Chart 14 Bond Yields and 10-year Yield Differential Between Denmark and Germany

Source:

Nykredit (data on gross issues).

Note:

Weekly observations. The average mortgage-credit yield includes 5, 6, 7 and 8 per cent series with weights corresponding to their shares of gross issues in Nykredit's open series. From the beginning of September 1999 the year of maturity for the mortgage-credit bonds was 2032 rather than 2029, which resulted in a small interest-rate increase (0.10-0.15 per cent). Furthermore, the 8 per cent series was opened at the beginning of September 1999, which also contributed to an increase in the average interest rate.

The increase in long-term mortgage-credit yields and the wider differential between short-term and long-term interest rates induced an increasing number of home owners to raise mortgage-credit loans at floating beholds interest rates, called adjustable-rate loans, whereby the rate of interest during the term of the loan can vary, cf. p. 64.

The future instalments on adjustable-rate loans are unknown since market interest rates can vary considerably during the term of the loan. The instalments on a conventional fixed-rate loan are known throughout the term of the loan. Chart 15 shows the rate of interest for Treasury notes with a maturity of between 1 and 2 years for which in mid-December the rate of interest is fixed for one year ahead. The chart illustrates that the interest-rate fluctuations seen in the last three years are moderate compared to the fluctuations earlier in the 1990s when inflation was also low. The assumption that the relatively low interest rates since 1996 will be stable for many years to come is associated with a certain risk. International interest rates may rise, or the Nationalbank may be obliged to raise interest rates considerably to counter speculative pressure against the krone. In such situations the Nationalbank cannot take into consideration that private home owners will also be affected.

Chart 15 Rate of Interest for Treasury Notes with a Maturity of 1-2 Years, Fixed for One Year

Note:

The interest rate in mid-December is fixed for one year.

Capital Flows and the Foreign-Exchange Reserve

The surplus on the current account of the balance of payments is estimated to be in the range of kr. 10 billion in 1999, cf. Table 3. Private capital flows entailed net capital imports of kr. 52 billion. The Nationalbank purchased foreign exchange for a net amount of kr. 63 billion and for the year as a whole the foreign-exchange reserve increased by kr. 64 billion excluding value adjustments. At the close of 1999 the foreign-exchange reserve amounted to kr. 165 billion, cf. Chart 16.

Table 3 Capital Flows

Net receipts, kr. billion	1998	1999
Current account of the balance of payments	-14	10
Capital transfers	0	1
Private capital flows:
Portfolio investments1	-42	-33
Direct investments	-32	-5
Financial derivatives	-1	4
Lending and deposits3	29	88
Estimate of unrecorded commercial credits	7	1
Errors and omissions	-5	-3
The Nationalbank's net purchase of foreign exchange	-29	63
Used as follows:
To reduce the central government's foreign debt	22	-2
For the central government's sale of Tele Danmark	-21
To increase the foreign-exchange reserve	-29	64

Note:	Excluding value adjustments, etc.
1	Excluding the central government's foreign bond issues.
2	Excluding the central government's sale of Tele Danmark shares.
3	Excluding the central government's foreign bank loans.

Chart 16 The Foreign-Exchange Reserve

Note:

End of month.

Portfolio investments in 1999 led to net capital exports of kr. 33 billion. Recent years' considerable net purchases of foreign securities by residents continued and their net purchases in 1999 amounted to kr. 67 billion, of which equity securities accounted for kr. 43 billion. In 1999 non-residents' net purchases of krone-denominated bonds were kr. 7 billion while their purchases of Danish bonds denominated in foreign exchange amounted to kr. 28 billion. Danish bonds denominated in foreign exchange were mostly short-term bonds denominated in euro issued by Danish banks. There were no net capital flows related to Danish shares in 1999.

Lending and deposits vis-à-vis abroad resulted in considerable net capital imports of kr. 88 billion in 1999. The net external liabilities of Danish business enterprises and private individuals increased by kr. 34 billion, which is especially due to an increase in residents' borrowing abroad in foreign currency. Furthermore, the banks' external position rose by kr. 58 billion. This increase in foreign-currency denominated liabilities may relate to the hedging of the exchange-rate risk in connection with residents' considerable net purchases of securities issued by non-residents, but may also be attributable to forward cover of exchange rates in connection with goods transactions or open positions in the foreign-exchange market.

As a consequence of the Nationalbank's considerable purchases of foreign exchange and sales of kroner in the market in 1999 there was an increase in the net krone position of the banks and mortgage institutes, i.e. their total accounts in kroner with the Nationalbank, cf. Chart 17. The substantial day-to-day fluctuations can be attributed to central-government receipts and disbursements. These payments have a neutral impact on the net position for the year as a whole since the central government's gross borrowing requirement (excluding foreign redemptions) is financed in full by issuing domestic krone-denominated government bonds.

Chart 17 Accounts of the Banks and Mortgage-Credit Institutes with the Nationalbank

Note:

The mortgage-credit institutes are included as from 21 June 1999.

The Monetary-Policy Instruments

The Nationalbank fundamentally conducts monetary policy via the terms for the overnight current-account deposits of the banks and mortgage-credit institutes with the Nationalbank, as well as the Nationalbank's weekly market operations. Via the weekly market operations each Friday the banks and mortgage-credit institutes may raise 14-day loans at the lending rate against government bonds and mortgage-credit bonds as collateral (the Nationalbank supplies liquidity), or place funds by purchasing 14-day certificates of deposits (the Nationalbank absorbs liquidity). The rate of interest for certificates of deposit is identical to the lending rate, while current-account deposits accrue interest at the discount rate. The interest rates on these instruments constitute the central element of monetary policy.

In connection with the weekly market operations the banks and mortgage-credit institutes will normally tailor their net position to providing current-account balances to cover the expected liquidity requirement for the following week. If large central-government receipts or disbursements are already foreseen, the Nationalbank will repurchase/sell certificates of deposit during the week, subject to pre-announcement. Should major unforeseen liquidity fluctuations occur the Nationalbank may repurchase/sell certificates of deposit extraordinarily without pre-announcement.

With effect from 21 June 1999 the Nationalbank's monetary-policy instruments were amended in a number of respects, cf. Monetary Review, 2nd Quarter 1999, p. 15. These adjustments were primarily of a technical nature and did not affect the overall framework for the conduct of monetary policy. The adjustments gave the mortgage-credit institutes access to the monetary-policy instruments on equal terms with the banks. The Nationalbank's repurchase agreements were restructured as lending against collateral. This restructuring required a technical adjustment of the provision of collateral, which entailed several practical and administrative advantages. The collateral provided by the counterparties in connection with monetary-policy loans, loans for cash depots and intra-day credit is now placed in a shared collateral pool. This makes the counterparties' provision of collateral to the Nationalbank more flexible. Furthermore, the restructuring of repurchase agreements as lending against collateral has made it possible to settle the monetary-policy loans with immediate liquidity effect.

The collateral basis was expanded from government bonds alone to include mortgage-credit bonds. The lending basis was thereby increased significantly. In order to prevent use of current-account balances for speculation in fluctuations in exchange rates or interest rates, limits were introduced for the current-account deposits of each bank or mortgage-credit institute. These limits total kr. 19.93 billion. If the total limit is exceeded, deposits in excess of the individual limit for each bank or mortgage-credit institute are converted to certificates of deposit. The overall ceiling has not been exceeded, but in a few cases the total current-account balance was close to the limit. Since the differential between the discount rate and the rate of interest for certificates of deposit was as low as 0.10 per cent for a period in 1999, the incentive to hold certificates of deposit rather than a liquid current-account balance was inadequate, and the system came under a little pressure. In connection with the raising of interest rates on 4 November 1999 the spread between the rate of interest for certificates of deposit and the current-account rate widened to 0.30 per cent, and widened further to 0.35 per cent when interest rates were raised on 3 February 2000. Since the widening of the interest-rate differential there has been no pressure on the overall ceiling for current-account deposits.

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Footnotes

[1] Euro Overnight Index Average, or EONIA, is a weighted average of the rates of interest for uncollateralised overnight transactions reported by a panel of major banks which are active in the euro money market.

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Version 1.0 April 2000 Nationalbanken.
Published by Danmarks Nationalbank April 2000, http://www.nationalbanken.dk