CLOSE TO CAPACITY

By Steen Bocian,
Director of Department, Danske Bank

The economic upswing remains in ro bust good health. High consumption and investment growth and strongly climbing exports are helping ensure that unemployment will hit new record-lows in the coming years. We expect the number of jobless to fall to around 110,000 by the end of 2007, equivalent to an unemployment rate of 4.1%, a level not seen since the early 1970s.

But such low levels of unemployment raise the question of whether the economy risks being derailed – will the Danish economy overheat? There is no doubt that the risk of this happening has increased considerably in recent years. The high level of capacity utilisation is already having some impact on the economy, and it is likely the fallout will increase in the years ahead as the upswing continues. However, this is not synonymous with the Danish economy being on the brink of a crisis.

Overheating – assuming no political intervention – does not necessarily have an abrupt effect on the economy. Overheating typically makes itself felt via accelerating wage growth, which squeezes competitiveness and exports. In other words, rapidly rising wages do cost jobs, but only in the longer term. In the short term, higher wage growth will actually increase economic activity as a result of increased purchasing power. The economic climate will not change radically in the short term if wage growth is pushed to say, 4.5%, which is what we expect in 2007, though that does not mean it will not have negative employment consequences in 2008 or 2009. It is during the good times that the seeds of future downturns are sown.

Previous downturns that arrived on the heels of periods of high growth have, however, not been without political intervention. Typically, current account or structural imbalance considerations have forced drastic economic measures to be enacted. Looking at the present current account situation, there is no doubt that the surplus is under pressure, but it still looks rather healthy, and so the politicians are not being forced into action. Thus any eventual overheating is more likely to unfold under the economy’s own terms, and we believe the risk of a sharp downturn in the wake of the current period of high growth remains limited.

The Danes’ propensity to spend appears to be holding at a high level, and it looks like private consumption may grow by around 3.7% this year. Hence 2006 seems set to be the third year in a row when private consumption growth will hover around 3.5%. The last time such a pattern of consumption growth was seen was back in the mid-80s – before the “potato diet” austerity package, tax reforms and increased interest rates put a stop to that particular spending spree.

There are several reasons behind the strong upsurge in private consumption in recent years. First and foremost, Danes have had more money in their pockets, having enjoyed tax cuts, low interest rates and handsome real wage growth. On top of this, wealth has soared. In fact, Danes have never been better off. Every Dane possesses a net wealth of DKK 850,000 – a rise of DKK 400,000 since 1998.

The housing market has been the prime reason behind the surge in wealth in Den-mark. In the past year alone, house prices have risen by around 25%. This stimulates private consumption, as greater wealth holdings reduce the need to accrue savings. Furthermore, some homeowners have chosen to release a portion of their home equity for consumption purposes.

Looking beyond 2006, we expect that consumption growth will slow to a more moderate level. Stable and continuing real wage growth in the region of 2%, a robust labour market and the wealth gains of recent years will tend to support high levels of private consumption growth. Pulling in the opposite direction will be rising interest rates, high energy prices and the endogenous dynamic in consumption. Overall, consumption looks set to grow by around 2.2% in 2007.