Geopolitical tensions, notably involving Venezuela and Greenland, have significantly influenced currency markets at the outset of 2024, with impacts now visible within Denmark's domestic currency scene. The Danish krone (DKK) has been notably weaker against the U.S. dollar, while the EUR/DKK exchange rate has surged to levels unseen since the early days of the COVID-19 pandemic.
Bank of America Securities outlined these developments in a detailed note dated January 20, emphasizing Denmark’s unique position as the sole European nation currently engaged in the Exchange Rate Mechanism II (ERM II). This framework allows Denmark to maintain its currency within a strict band of plus or minus 2.25% relative to a central peg rate set at 7.46038 for EUR/DKK.
The critical focus remains on how far and how swiftly the EUR/DKK rate deviates from this central rate. This parameter is essential for the Danish central bank’s assessment. Since the start of this year, the crossing of the near-tolerance limit stands out as only the fourth occurrence since ERM II’s establishment. This signals significant currency pressures warranting monitoring.
Historically, the Danish krone has only reached this extent of deviation in three previous instances, according to Bank of America Securities: the year 2000, when Denmark rejected joining the Eurozone; 2015, subsequent to the Swiss National Bank’s decision to abandon its peg and exert influence on other managed exchange rate regimes; and the period spanning 2019 to 2020, marked by differing liquidity policies between the Danish central bank and the European Central Bank (ECB).
These precedents provide a clear guide to anticipated central bank behavior under current conditions. Bank of America Securities expects Denmark’s primary response tool will again be foreign exchange interventions. The Danish central bank appears well positioned to implement such measures given its substantial foreign exchange reserves, valued at nearly 22% of gross domestic product, close to record highs.
While adjusting the policy rate spread—now favoring the ECB by 25 basis points—is another potential option, it would likely be secondary to direct market interventions. There remains a possibility of assistance from the ECB due to Denmark’s supervisory role over the ERM II framework, if intervention alone does not suffice.
In summary, Bank of America’s analysts underscore their expectation that the Danish krone’s peg within ERM II will continue to hold despite current pressures, supported by a robust response toolkit and historical precedent for intervention.