Denmark just joined the deflation club as it scrambles to defend its currency peg

Denmark Danish fan upsetREUTERS/Alexander DemianchukSomething is rotten in the state of Denmark.

Denmark just joined the deflation club.

Consumer prices fell by 0.1% in the year to January, according to figures just released. That’s Denmark’s first bout of falling prices since at least 1954.

Denmark’s central bank has cut interest rates an astonishing four times in the last four weeks.

That’s because it’s importing deflation from the eurozone: Denmark’s currency, the krone, is pegged against the euro as part of the European Exchange Rate Mechanism.

Unlike Switzerland, which recently abandoned its peg against the euro after more than three years of use, Denmark has managed its currency as part of the ERM since the 1980s.

In practice, this means that Denmark’s central bank has to keep buying up euros to try to strengthen the eurozone’s currency, and weaken its own. Here’s what Capital Economics said about that when the Nationalbank last cut rates on 5 February:

Nationalbank Governor Lars Rohde today said that “there is no upper limit to the size of the foreign exchange reserve”, no doubt in an effort to set the Denmark apart from Switzerland, where the growing FX reserve eventually led to the abandonment of the cap. But given the ineffectiveness of the measures taken so far, Danish QE is looking increasingly likely.

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