Interest rate cut sparks warnings on Denmark ditching euro peg

Denmark dampened a rally in European financial markets on Monday after a cut in interest rates sparked warnings that it could follow Switzerland’s lead and end the krone’s peg to the euro.
The Danish central bank shaved 0.15 percentage points off its base rate to discourage investors from switching their funds out of eurozone banks ahead of the European Central Bank’s expected launch of quantitative easing this week.
The warning of a swift climbdown by Copenhagen undermined a strong surge in European shares which hit a seven-year high earlier in the day. The FTSE 100, which had climbed 78 points in mid-afternoon, finished the day up on 35 points at 6585. The Paris-based Cac following a similar path, finishing up 50 points before falling back to close only 30 points ahead.
The French prime minister François Hollande, anxious for the ECB to begin flooding the eurozone economy with extra funds, was forced to backtrack after appearing to announce that the central bank was ready to start buying eurozone sovereign debt.
“On Thursday, the ECB will take the decision to buy sovereign debt, which will provide significant liquidity to the European economy and create a movement that is favourable to growth,” he said in a speech to business leaders at the Élysée Palace.
Later, a spokesman said he was only talking theoretically and referring to QE as a “hypothesis”.
Speculation that the ECB will kick off a major spending spree has sparked increasing volatility in financial markets, especially since a European court of justice ruled that it was legal under EU law.
Last week, and only two days after the court ruling, Switzerland’s central bank chief blamed an imminent QE bonanza for his decision to cut rates to -0.75% andend a longstanding policy of tracking the euro. In a frenzy of trading on international currency markets, the Swiss franc jumped 30%.
Investors have sold the euro heavily in advance of QE, switching their allegiance to the fast-growing US economy and the dollar. In the last seven months the euro has lost 20% of its value against the dollar and could lose another 10% or 20% once QE takes effect.
Under QE, the ECB is believed to be ready to supplement its existing purchase of corporate bonds with tranches of government debt following a meeting of its governing council on Thursday. Some analysts believe only a programme worth €1tn (£767bn)will convince markets that the ECB is serious about tackling low inflation, while others say €750bn would be enough.
Foreign exchange dealer Clear Currency said: “Markets are expecting [the ECB] to announce a QE programme, €500bn would be at the low end of expectations with a programme of €750bn probably enough to appease markets.”
One plan believed to be under consideration would restrict the Frankfurt-based central bank to buying the debt of countries such as Germany and Finland, which are considered a safe bet. However, Mario Draghi, president of the ECB, has come under intense pressure from the leaders of southern European states to spread his net wider and buy government bonds from all 19 member treasuries. They are keen for cheaper funds to spur business lending and growth.
A steep fall in inflation in recent months has also raised the spectre of declining prices, which the ECB must avoid or risk deflation and a fall back into recession. European politicians from Paris to Vienna were shocked this month when figures showed with prices in December falling 0.2% prices falling 0.2% in December.
But the German chancellor Angela Merkel remains opposed to QE and has lobbied against Thursday’s announcement. Berlin has argued that the fall in inflation follows steep falls in oil prices, which may prove temporary. It has also stressed that the risks of sovereign bond purchases from the treasuries of weaker countries should be underwritten by the national central banks of those states.
Analysts at Morgan Stanley said a compromise is the likely outcome, limiting the impact. “A workable compromise for the ECB would be a hybrid programme with a core component in which financial risk is shared across the eurosystem, and an optional component relating to national central bank risk,” said the investment bank’s European economist, Elga Bartsch.
“We remain sceptical on the impact of sovereign QE because of the dissent inside the ECB, the potential political backlash, the legal uncertainties on government bond buying, and the Greek situation and its complex execution.”
To emphasise the extent of dissent inside the eurozone, the Irish finance minister Michael Noonan said buying Irish bonds and making the Irish central bank take the risk for their failure was self-defeating.
“If [QE] is going to be renationalised and if monetary policy becomes a function of national central banks acting as agents of Frankfurt I think it will be ineffective,” he said.
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