European Central Bank May End Longest Experiment in Negative Interest Rates

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The world’s longest experiment in negative interest rates may be coming to an end, as officials in Denmark prepare to follow possible increases in borrowing costs in the neighboring euro zone.

With European Central Bank officials abruptly signaling a shift toward a more hawkish policy this month, economists now expect Nationalbanken in Copenhagen to raise interest rates in lockstep with their counterparts in Frankfurt through 2023. Benchmark borrowing costs could then turn positive for the first time since 2014.

That would draw to a close an era that saw Danes pioneer a cutting-edge approach subsequently followed from the euro region to Japan.

Asset prices responded, with Denmark’s benchmark stocks index outperforming Europe’s Stoxx 600 in eight out of the past 10 years, and house values rising 40% higher between 2014 and 2021. At one point, mortgage rates even turned negative.

Much like elsewhere, the policy left citizens divided over the impact. Banks, whose profits came increasingly under pressure, said in 2019 they may no longer shield individual depositors from negative deposit rates. That prompted clients to slow saving and invest, sometimes in riskier assets, raising concerns about households’ exposure to market shocks.

“For many, the negative rates have been an abnormality and I’m sure that especially the banks will be happy to see them go away,” Frederik Engholm, chief strategist at Nykredit, said. Still, “when we see rates going positive again, there’s a risk that some homeowners might get squeezed,” he said.

In Denmark’s unusual mortgage market, lenders operate as brokers and make money collecting fees that have steadily increased over the years. That’s one reason central bank Governor Lars Rohde has said he’s not worried about lenders’ ability to cope with subzero policy.

Nationalbanken, which doesn’t make forecasts about its own path for borrowing costs, declined to comment.

Officials, though, have said that negative rates function more or less the same way as very low ones and that it hasn’t yet discovered a floor for how deep it can cut.

The central bank, whose monetary policy focuses on stability in the krone, first delved below zero in 2012. It took a brief interlude in positive territory in 2014 before then moving down again as the ECB went negative. The Swiss National Bank, Sweden’s Riksbank and the Bank of Japan also adopted the policy.

Rohde faced the most dramatic period during the subzero experiment in early 2015, when investors attacked the krone’s peg, betting it would break. The central bank fought back by cutting its rate to minus 0.75% and dumping about 275 billion kroner ($42 billion) on the currency market.

Denmark’s Peg

Nationalbanken’s key mandate is to defend a 2.25% band around an exchange rate of 7.46038 against the euro. In practice, it has only tolerated moves within 0.1%. It uses currency interventions and changes its policy rate to steer the krone. The central bank doesn’t have an inflation target, although one of its other mandates is to “contribute to the stability of the financial system.”

Looking back at the whole policy, Jan Storup Nielsen, chief analyst at Nordea Markets in Copenhagen, reckons its scope and duration has shown just how determined Denmark is to keep its currency stable.

“The Danish central bank has underlined its willingness to go very far and further than most expected to defend the peg,” he said. “You might have expected Danes to turn against the peg with the consequences of negative interest rates, but we haven’t seen that at all.”

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