DANISH ECONOMY FLOURISHING

By Steen Bocian, Chief Analyst, Danske Bank

ECONOMY: As we come to the end of 2006, it seems only natural to cast a glance back at the year that was and look forward to the year ahead. 2006 was the third year of the economic upswing which started for real in the Danish economy at the beginning of 2004. Growth in 2006 was in excess of 3.5%, which enabled the already low level of unemployment at the start of the year to fall further. Looking ahead to 2007, there is everything to suggest that the upswing will continue – but the upswing is not bullet-proof. We therefore expect it to draw to a close towards the end of 2007, leaving us with a slightly more subdued economic climate in 2008.

Broad-based economic upswing

Looking more closely at economic developments in 2006, it was not just a year of strong growth. This growth was also unusually broad-based. Consumer spending continued to rise thanks to good job growth and soaring house prices. Business investment also played a part. Persistently low interest rates, coupled with high capacity utilisation and a still favourable growth outlook, prompted a surge in investment activity in the business sector, further boosting growth. Danish exports also surprised on the upside. This meant that the upswing was fuelled by all parts of the economy – and the benefits were plain to see.

Unemployment keeps on tumbling

This strong economic growth enabled the slide in unemployment which started at the beginning of 2004 to continue, and unemployment is approaching just 4.0% of the workforce at the end of 2006. This is the lowest level since the early 1970s and a decrease of 2.5 percentage points in just three years. Low unemployment is good news, of course, but it does bring a number of challenges in terms of the future of the upswing. More and more businesses are reporting a shortage of labour – and this problem is set to escalate if the upswing continues. So far the historically tight labour market has not had any major impact on wage formation. Wage growth has risen only marginally – in the third quarter wages were 3.2% up on a year earlier, which is still a very modest rate of growth. 2007 will bring the renegotiation of pay settlements across large parts of the Danish labour market. The big settlements do not play the same role as they did 15-20 years ago, but they still send out strong signals. It will therefore be interesting to see how great an impact the tight labour market has on the negotiations and, consequently, wage formation.

Strong wage growth could, in fact, be the factor which ultimately derails the Danish upswing, and indeed this is what we expect to happen. However, this will not be a sudden affair. Slightly higher wage growth will eat into economic growth only gradually, and so the labour market does not pose any immediate threat to the economic upswing in 2007. But when we look ahead to 2008 and 2009, we expect this to be one of the reasons why the upswing slowly but surely peters out.

Favourable current account and fiscal balances

If the upswing does simply peter out, the shape of the current upswing will be very different to that typically seen in the Danish economy. Normally economic upswings have put pressure on the current account, forcing the politicians to react by tightening fiscal policy, but this has not been the case this time around. The current account is expected to show a surplus of 2.1% of GDP in 2006. While this is slightly lower than in 2005, we are not talking about any real pressure on the current account. The continued healthy surplus is the result of 20 years of reformist economic policy – together with an element of luck in the form of North Sea oil revenue and healthy earnings at Danish shipping companies.

The absence of current account problems has allowed the upswing to be longer-lived than previous ones, and for once the end of the upswing will not be driven by fiscal policy tightening. This time around, the upswing is set to draw to a close on the economy’s own terms, which gives grounds for optimism about it being a soft landing.

If we were to highlight just one risk factor in the economy which could trigger a more abrupt economic reaction, it would be the housing market. As in many other Western countries, house prices have risen rapidly in Denmark over the last decade. There is now much to suggest that the market is about to turn – the time it takes to sell a home is growing fast, and the number of homes up for sale is higher than for a long time. Whether this heralds the onset of a soft or hard landing in the housing market is still too early to say with any certainty, but if it is a hard landing, the economic repercussions will be considerable.

For the time being, we remain optimistic. As long as interest rates do not rise sharply, we believe that the housing market will make a soft landing. The upswing will therefore be able to continue for a while yet before the tight domestic capacity situation slowly takes the wind out of the economy’s sails, leading to subdued growth and slowly rising unemployment –but not until 2008. 

 
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