Reuters: US Dollar Report: Investors pick up Danish crowns as euro break-up hedge

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Investors pick up Danish crowns as euro break-up hedge May 24th 2012, 12:17 Thu May 24, 2012 8:17am EDT * Danish crown favoured as hedge against euro break-up * Central bank could struggle to keep tight EUR/DKK band * Another Danish rate cut likely, possibly on Thursday * Talk of central bank intervention to curb crown -traders By Jessica Mortimer LONDON, May 24 (Reuters) - Investor demand to buy the Danish crown as protection against euro break-up is growing, raising the prospect that Denmark's central bank may struggle to keep it in its tight trading band against the common currency if the euro zone crisis worsens. The crown has risen to a five-month high against the euro, mirroring a sharp appreciation late last year due to flight out of euro zone assets before the European Central Bank's injection of long-term funds calmed markets. But since inconclusive Greek elections earlier this month sparked fears of a chaotic euro exit there has been renewed interest in the Danish crown as market players have sought alternatives to a sagging euro. This has led to talk that the central bank may be forced to raise interest rates, which it could do as early as this week. Investors are betting that if the euro broke apart, Denmark would peg the crown to Germany's currency, whether the euro or a successor, as Germany is Denmark's biggest trading partner. Buying crowns is seen as a way of gaining exposure to Germany without the risks associated with holding euros. "Some investors see the Danish crown as a substitute for the Deutschemark in case of a break-up. That's why we see interest to buy it," Danske Bank currency strategist Morten Helt said. Denmark is in the European Union but not the euro zone, having voted against adopting the currency in a referendum in 2000, but its central bank, the Nationalbank, intervenes to keep the crown pegged within a band against the euro. It has a history of maintaining interest rate targets. The crown was pegged to sterling in the late 1930s, to the dollar-based Bretton Woods system after World War Two and to the German mark from the 1970s. Danish assets also appeal because the country is triple-A-rated, has a large current account surplus and low public debt. Analysts said longer-term investors, such as central bank reserve managers, have bought Danish government bonds, while short-term speculators, such as hedge funds, are using options to bet on further crown gains. "There has been some foreign buying of Danish government bonds and also Danish investors selling foreign bonds," said Niels Christensen, currency strategist at Nordea. The yield on 10-year Danish government bonds hit a record low around 1.226 percent on Thursday. This is lower than the yield on 10-year German bonds, the euro zone benchmark,, which touched a low of 1.351 percent. Investors are also attracted to Danish crown options, which are relatively cheap because the peg to the euro means the market expects little movement in the exchange rate. Christensen said one-year euro/Danish crown implied volatility - a measure both of options pricing and of expectations of future price movements - rose to 1.75 percent this week from around 1 percent in early May. It stood at 1.60 on Thursday, he said. The euro hit a five-month low of 7.4310 Danish crowns on Wednesday and again on Thursdsay. In early May it traded around 7.4390. In the second half of 2011, the euro dropped to 7.4299 crowns by mid-December, its lowest since 2004, prompting the central bank to cut interest rates. RATE CUT? The Nationalbank aims to keep the crown within a band of plus or minus 2.25 percent around a central rate of 7.46038 per euro. In practice it has kept the band much tighter, intervening in currency markets when needed and sometimes through adjustments to interest rates. But this could be an uphill battle. Analysts at SEB said a "disorderly euro zone development" could test the lower end of the official band, 7.29252. This could give Denmark a similar dilemma to Switzerland, which has kept the euro just a shade above the floor it has set of 1.20 Swiss francs per euro. Traders cited talk the Danish central bank was prompted to intervene on Wednesday by buying euros around 7.4311 crowns. "When we have previously had levels below 7.4320-25 we have seen the currency reserves increase quite a lot, showing they have intervened," Danske's Helt said. Alternatively, the central bank could cut interest rates in an effort to diminish the appeal of Danish assets compared with those of euro zone members. Sydbank chief economist Jacob Graven said in a note that a 10 basis point rate cut was possible as early as this week. The central bank does not have scheduled meetings but it has tended to announce rate moves is 1400 GMT on Thursdays. This would take the main policy rate to a record low 0.6 percent, 40 basis points below its euro zone equivalent. Bets on the Danish crown gaining are not without risks. The currency is not widely traded and, like its Scandinavian counterparts, the Norwegian and Swedish crowns, could be vulnerable if investors flee risky assets. In late 2008, the crown fell sharply after the collapse of Lehman Brothers prompted investors to shed riskier assets. This led the central bank to hike interest rates when others were cutting to stimulate their economies. "Primarily what's driving this (demand for the Danish crown) is the low volatility, the fact that it's relatively cheap to buy as a punt on euro break-up," said Carl Hammer, chief currency strategist at SEB in Stockholm. Link this Share this Digg this Email Reprints

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