Reuters: US Dollar Report: UPDATE 1-Investors pick up Danish crowns as euro break-up hedge

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UPDATE 1-Investors pick up Danish crowns as euro break-up hedge May 24th 2012, 15:27 Thu May 24, 2012 11:27am EDT * Danish crown favoured as hedge against euro break-up * Central bank cuts interest rate to curb crown * Bank says cut followed foreign exchange purchases * Analysts see tough job to keep tight EUR/DKK band 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. 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. The central bank cut interest rates on Thursday to curb the crown, in what analysts said was an effort to make the currency less attractive. The cut took the main policy rate to 0.6 percent, 40 basis points below the euro zone equivalent. 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. 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 Thursday. 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. UPHILL BATTLE 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, by intervention and 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. 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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