DANISH ECONOMY

Danish economy: From quickstep to slow foxtrot

BY SENIOR ECONOMIST FRANK ØLAND HANSEN, DANSKE BANK

The Danish economy has expanded rapidly in recent years – perhaps a little too rapidly. Unemployment has fallen for 36 months in a row and a shortage of labour has squeezed wage growth higher. Now, however, the outlook is for the Danish economy to get some much-needed breathing space. The slower tempo is due, in particular, to the weakness in the housing market and the impact of the global financial crisis. We do not expect the beat to pick up until 2010, when the housing market may also achieve some balance. Had the economic quickstep continued, we may have had to sit out the next dance.

The need for a slowdown is most evident when one looks at the labour market. The number of unemployed has fallen to just 1.6% of the labour force – the lowest level since 1974. From July to August the number of unemployed stood unchanged at just 45,600 persons, which may well be a turning point. It is very difficult to pinpoint the true level of structural unemployment, but the accelerating wage growth of recent years suggests that unemployment is well below the long-term sustainable level. Danish competitiveness has come under great pressure in recent years as a result of accelerating wage growth, low productivity growth and depreciation of the US dollar. Without a change of weather, Danish wage growth would most likely be elevated for a prolonged period, which would result in a substantial loss of competitiveness – and a longer and deeper economic downturn.

We consider developments in the housing market to be the single greatest risk factor for the performance of the Danish economy in the coming years. The housing market may indeed make the difference between the somewhat bumpy landing for the Danish economy that we consider the most likely outcome, and a hard landing. Official price statistics paint a picture of a housing market that is under pressure but not in real crisis. House prices nationwide have fallen by just under 4% since peaking, but there are major regional variations. Continued growth in the number of homes for sale and very modest turnover do nevertheless suggest that the limited decrease in house prices to date will not be enough to bring the market into equilibrium. We therefore expect the coming years to bring further declines in house prices. House price deflation has historically proved relatively persistent – once sentiment has changed, it can be hard to bring buyers back into the market, and so there is a risk of the downturn becoming self-perpetuating. A longer and harder landing in the housing market could drag the rest of the economy down with it.

Surprisingly perhaps, Danish consumers are still optimistic about their own financial situation. While the many negative news stories – not least about the financial crisis – have caused Danes to take a very pessimistic view of the country’s economy in a year’s time, their assessment of their own economic situation is largely unchanged and positive. This view is perhaps not entirely misplaced, as unemployment remains at a record low, tax cuts may be on the cards, and the fall in house prices has only eroded a modest amount of the home equity of the average homeowner.