By Steen Bocian, Chief Analysist, Danske Bank
In the world of sports, new records always grab a lot of attention. The Danish economy is in a phase where it is setting new records almost at will. Both businesses and households have greater confidence in the future than ever. Growth in house prices and retail sales has surged to new highs, and Den-mark is running record surpluses on its current account and budget balances. On top of this, unemployment has plummeted almost to a 30-year low.
Last year, the Danish economy expanded by 3.4% –nearly double its trend growth rate. While the upswing in 2005 was driven by a surge in consumer spending, surprisingly strong growth in both exports and machinery investment helped broaden the expansion compared to the early stages of this recovery.
Consumer spending has been growing at a strong rate since mid-2003 and last year expanded by 3.5%. Consumers’ appetite for spending is driven, not least, by the boom in Danish house prices in recent years. The value of an average home rocketed by DKK 250,000 from the fourth quarter of 2004 to the fourth quarter of 2005, and home values in the greater Co-penhagen area tripled this rise. The growth in home values has made many homeowners cut down on their savings, and they will hence distribute their wealth gains across their entire lives. This is the reason consumer spending is outgrowing income.
As the Danish economy has expanded, unemployment has fallen steadily since winter 2003/ 2004. Over the past two years, the number of people out of a job has decreased by 46,400. The sharp drop in joblessness has taken the official unemployment number down to its lowest level since 1976, at 139,600, or 5% of the labour force. This has put the spotlight on the efficiency of the Danish labour market. There is already now a shortage of labour with certain qualifications and hence a looming danger of the Danish economy overheating.
As the unemployment benefits system in Denmark is rather extensive, it is not very likely that unemployment can be pushed much further down. True, lower unemployment rates were seen in the 1960s, but the benefits system was not as far-reaching in those days. Thus the Danish economy is now sailing into uncharted waters. The tight capacity situation has as yet had no visible effect on wages, with the latest data showing growth from Q3 2004 to Q3 2005 of 2.8%. However, we do expect that accelerating wage growth will eventually squeeze Danish competitiveness over the next few years.
Meanwhile, the tight labour market will boost investments in the coming years. Investment in machinery shifted into high gear in 2005 and we expect this trend will continue in 2006. The rapid pace of investment growth will lay the foundation for relatively high growth in productivity per worker and this should help offset some of the pressures that might arise in the Danish economy. Increased investment activity will, in addition, cause imports to rise.
Although we see imports rising, we do not, however, expect the current account to suffer unduly in 2006. This is because the biggest economic surprise of recent years has been exports. While domestic growth has been very robust, exporters managed to increase their market share in 2005 – industrial exports, for instance, jumped almost 10%. Part of the explanation for this fine performance was a favourable movement in the euro/dollar exchange rate that benefited Danish competitiveness. However, this does not fully explain the positive developments, meaning Danish exporters have simply been good at adapting to a difficult market. This tends to make us optimistic on exports going forward, even though the tight labour market will put some pressure on Danish competitiveness.
