With the US dollar on a tear higher and the Euro sliding on the back of weaker economic underpinnings, the stage is set for a further rally in the USD/DKK pair despite the fact that any renewed Euro softness is likely to test the Danish Central Bank’s resolve to maintain the currency peg. After experiencing meager growth at best and no inflation, among the most negative interest rates, Denmark has fallen short of insulating and expanding business activity in the face of these other challenges. While the United States Federal Reserve looks poised to raise rates further during the calendar year, the outlook for Danmarks Nationalbank is more clouded considering the need to keep an eye on the unfolding situation in the neighboring Euro Area.Should the Euro Area need more stimulus and accommodation, the pressure will be on Danish policy makers to match the efforts to keep the Krone weak.
A Long Running Peg
The Danish Krone has long been pegged to the Euro, as despite being a member of the European Union, Denmark chose to opt out of the Monetary Union and common currency. Before the Euro, the Danes had the Krone pegged to the German Deutsche Mark in an effort to stabilize the currency, later transitioning this policy to fit the EMU paradigm.As such, the main intent of the Danmarks Nationalbank is maintaining and protecting this flexible peg that can trade within a 2.25% band higher and lower of the reference rate of 7.46038 Krone to 1 Euro, commonly referred to as the fixed-exchange-rate policy.Aside from the focus of maintaining the exchange rate mechanism, inflation is also expected to closely track European figures.  So far, it is working, with inflation sitting at 0.00%, slightly above the comparable Euro Area figure which last printed at -0.20%.
While the Danmarks Nationalbank has been successfully sustaining the peg to the Euro for years, there is growing concern that officials may face a moment similar to the Swiss National Bank when they were forced to scrap the peg back in 2015. Policies like negative interest rates which currently sit at -0.65% have been able to deter an influx of hot money that could threaten the peg, but the amount of room that the Central Bank can lower rates is not infinite.The risk factors are mounting, thanks in part to the prospect of the upcoming Brexit vote and the chaos it could unleash. Already, some investors and fund managers are preparing for a wave of safe haven flows that could result from a decision by the UK to exit. Should the peg dissolve, the USD/DKK pair could tumble sharply especially if the Krone appreciates rapidly versus the Euro.
