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More Danish rate cuts seen; next stop — wider FX band

* Crown seen as safer haven since Swiss scrapped cap

* Denmark using rate cuts, intervention to curb crown

* Still has bolder option of widening trading band

* Analysts do not see Denmark scrapping its peg

By Ole Mikkelsen

COPENHAGEN, Jan 30 (Reuters) – Denmark is likely to cut its deposit rate deeper into negative territory and could widen the crown’s trading band if bolder action is needed to relieve pressure on its currency peg.

Investors have piled into the Danish crown since the Swiss central bank shocked markets on Jan. 15 by scrapping the franc’s cap to the euro and cut interest rates to levels that are below Denmark’s, making the crown more attractive.

The European Central Bank’s decision last week to launch a landmark bond-buying programme with new money to weaken the euro has also bolstered the crown.

Rising pressure on the currency has spurred speculation that Denmark may follow the Swiss and scrap its 15-year-old peg to the euro. But, analysts say that is unlikely, pointing to a number of other options the central bank can resort to before having to consider abandoning the regime.

Under the European Union’s Exchange Rate Mechanism (ERM2), Denmark agreed to keep the crown at 2.25 percent either side of the parity rate of 7.46038 crowns to the euro. But in practice, the crown has not moved more than 0.5 percent on either side, as central bank intervention, when necessary, has kept it in check.

“The central bank has several tools they can use before they have to give up the fixed currency policy and so far they have only used two,” said Citi Economist Tina Mortensen.

“In addition to lowering interest rates further, they can build up reserves. But they can also reintroduce a three-year lending facility and they can use the fluctuation band more … Denmark can let the currency fluctuate 15 percent around the central parity and still meet ERM2 requirements,” she said.

While Denmark agreed to keep its currency very close to the euro, ERM2 rules allowed currencies of other participants, ranging from Cyprus and Malta to Slovenia and Lithuania, to fluctuate 15 percent either side of parity as a general rule.

A sluggish economic recovery in the European Union, prospects of deflation in some countries and political uncertainty due to factors such as the election of the far-left Syriza party in Greece are all weighing on the euro.

“With many uncertainties still facing the euro area and with Danish monetary policy already loose, the pressure will likely remain … and a recalibration of the current trading range cannot be ruled out,” Bank of America Merrill Lynch said in a note to clients.


Before a potential widening of the trading range, however, the central bank still has plenty of room to keep intervening and cutting interest rates to curb the crown. At the very least it could lower its benchmark rate to -0.75 percent to match the Swiss rate, or below, analysts said.

On Thursday, the Danish central bank cut its key rate to -0.50 percent, the third cut in two weeks.

Unlike Russia, which is burning up its foreign reserves to defend the ailing rouble, undermining financial stability, Denmark is building its reserves by intervening to curb a strengthening currency.

Jes Asmussen, chief economist at Handelsbanken Capital Markets, estimates that in January the central bank spent a record $ 100 billion ($ 15 billion) in foreign exchange markets by selling crowns to weaken the currency.

That suggests foreign reserves — which stood at 447 billion crowns ($ 68 billion) at the end of December, or a quarter of Danish gross domestic product — could bypass their record level of 514 billion crowns, held in July 2012. Foreign currency reserves data is due on Feb. 3.

As the Swiss central bank’s policies show, there is such a thing as having too much in reserves. The Danish level, however, is far off the 100 percent of GDP that the Swiss National Bank held before it scrapped the franc’s cap.

“The market is testing the central bank at the moment. The question is when the market realises that the central bank will insist on keeping the crown close to the euro,” chief economist Helge Pedersen from Nordea said. ($ 1 = 6.5837 Danish crowns) (Additional reporting by Anirban Nag in London; Editing by Sabina Zawadzki and Susan Fenton)

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