A new wave of coronavirus has sent a chill wind through the Danish economy. But an efficient roll-out of vaccines and the experience from 2020 spark hopes that springtime for the economy is just around the corner. Initially, the upswing will likely be driven by rising household consumption supported mainly by a sharp pick-up in the housing market and large savings. Later in the year demand in Denmark’s key export markets should also grow, bringing overall activity back at pre-crisis levels during the spring of 2022.
2020 was a turbulent year for the Danish economy. After a solid start to the year the coronavirus pandemic hit economic activity hard during the spring, and GDP saw the biggest decline in recent times in Q2 2020. Subsequently, activity quickly rebounded, driven by a significant increase in household consumption. That was not enough to bring activity in 2020 into positive territory, however. We expect overall economic activity to have contracted by 3.7% – the biggest setback since the financial crisis in 2009.
Still, it is much better than feared when the pandemic first struck. It is also worth noting that the Danish economy has performed better than many other economies during the coronavirus crisis. The reasons include the relatively limited spread of the virus in Denmark, a large savings buffer built up before the crisis and a diversified and defensive export structure.
Rapid acceleration later in 2021
The year 2021 has started with fierce economic headwinds due to new restrictions to curb the spread of the coronavirus. Although the restrictions are much the same as those implemented in the spring of 2020, the economic effect should be less severe this time around. The key reason is that both public and private sector players were far better prepared to handle the challenges of the lockdown. Many government support schemes were reactivated, which has contributed to reducing the negative effects of the restrictions. Moreover, the start of the roll-out of vaccines has sparked hopes that the tough restrictions will be eased relatively soon; this will underpin both consumption and investment even during the period when large parts of the economy remain locked down.
Experience from Q3 2020 suggests that the underlying economic structures remain intact and that the long-term effects of the coronavirus crisis will be limited. This means that, unlike after the financial crisis, economic activity will relatively quickly return to normal when the virus is no longer a limiting factor. The Danish authorities expect most adults to have been vaccinated before the summer. But economic activity will likely start to recover sooner as the extensive restrictions mainly aim at protecting those most vulnerable to the virus, and they are the ones who are being vaccinated first. In light of this and the prospect of warmer weather, which also seems to reduce the spread of the virus, our baseline scenario assumes that the most stringent restrictions will be lifted in Q1 2021, prompting a rapid acceleration in activity as early as in Q2 2021.
Denmark: Macroeconomic Indicators
|Real GDP, % y/y||2.2||2.8||-3.7||2.5||3.5|
|Consumer prices, % y/y||0.8||0.8||0.4||0.8||1.1|
|Unemployment rate, %||3.8||3.7||4.6||4.5||3.7|
|Current account balance, % of GDP||7.0||8.8||7.9||6.4||7.1|
|General gov. budget balance, % of GDP||0.7||3.8||-2.5||-1.6||-0.4|
|General gov. gross debt, % of GDP||34.0||33.3||43.5||41.5||40.3|
|Monetary policy rate, deposit (end of period)||-0.65||-0.75||-0.60||-0.60||-0.60|
|USD/DKK (end of period)||6.53||6.66||6.08||6.11||6.32|
Huge spending potential among households
Despite the coronavirus crisis, Danish households have remained in relatively good shape thanks to the government’s extensive aid packages, a surprisingly buoyant housing market and not least the additional downward pressure on interest rates. Coupled with a stagnation in total debt, the lower interest rates have led to a marked decline in households’ total interest payments. In 2008 Danish households spent almost 17% of their disposable income on interest payments. This year that figure will be just over 2%, corresponding to a reduction in annual interest payments of some DKK 80bn.
With lower interest payments, sustained positive real wage growth, disbursement of three weeks’ frozen holiday pay and limited consumption opportunities especially in the locked-down services sector, households’ savings have increased during the coronavirus crisis. This savings buffer strongly underpins expectations of a significant pick-up in spending growth when the restrictions are lifted during the spring. It will be further supported by the disbursement of the last two weeks’ frozen holiday pay in March. Based on experience from October 2020, this disbursement is expected to provide a further boost to household spending.
But the composition of household consumption will differ compared with 2020. Due to the coronavirus restrictions in the services sector, retail sales rose sharply to an all-time high in October 2020. But when the restrictions are lifted again, especially consumption of services is expected to increase sharply. Also household demand for holidays abroad should rise dramatically. But unlike the other Nordic countries, Denmark runs a surplus on the tourism balance of payments, which means that the reopening of travel will benefit the Danish economy as a whole.
Exports under pressure
In many ways these are challenging times for Danish exports. Activity in key export markets is under significant pressure due to the coronavirus pandemic, and at the same time the trade-weighted DKK rate has appreciated to the strongest level in more than ten years. With the DKK appreciation, Danish goods and services exports have become more expensive, while imports have become cheaper. Overall, this toxic combination is expected to have triggered a decline in exports of some 9% in 2020. In that case, exports will have declined by as much as during the financial crisis in 2009. However, it is important to emphasise that a major part of this decline is due to a sharp drop in exports of services, including spending by foreign tourists in Denmark.
With expectations of sharply accelerating activity in key export markets in 2021, there is a good chance that Danish exports overall will recover strongly. The recovery will be further underpinned by the strong focus on the green transition evident in many fiscal policy stimulus packages implemented to boost economic activity. This is especially evident with the EU’s large recovery fund of EUR 750bn where at least 30% must be invested in projects supporting the green transition. This is an area where Danish companies traditionally hold a strong position.
COVID-19 has once again hit Denmark. But springtime for the economy is just around the corner.
Jan Størup Nielsen, Nordea Chief Analyst
Strong labour market recovery
During the lockdown in the spring of 2020, the number of wage-earners declined by almost 80,000, and unemployment rose by 2% points. But the labour market soon recovered, and two-thirds of the jobs lost had been regained when new coronavirus restrictions were introduced in late 2020. The new lockdown will likely drive up gross unemployment again in the first months of 2021. But as we saw last year, rising economic activity should relatively quickly start to push unemployment lower as the restrictions are gradually lifted. Consequently, we expect unemployment to return to pre-crisis levels in 2022 and thus to levels that are close to the long-term equilibrium level. The rising unemployment coupled with the overall uncertainty has led to downward pressure on private sector wage growth. But as consumer prices only rose marginally over the same period – annual inflation in 2020 was 0.4% – real wages have increased robustly.
Slightly higher long yields ahead
Over the past year the DKK has strengthened steadily versus the EUR, driven mainly by an increase in Danish short-term money market rates relative to Euro-area equivalents. The appreciation pressure on the DKK versus the EUR will probably persist in Q1 2021 as surplus liquidity in Denmark looks set to decline further. To counter this trend, the Danish central bank is expected to start selling the DKK. However, its intervention is not likely to include any independent Danish rate cut. We consequently expect the central bank to keep its certificate of deposit rate unchanged at -0.60% over the forecast period.
Long yields, on the other hand, are set to move slightly higher as we approach the end of 2022. This move will mainly be driven by a similar move in German yields. The expected increase in long yields will only to a limited extent adversely affect the level of economic activity. But towards the end of the forecast period, the economy could benefit less from easy monetary conditions.
Government budget deficit smaller than expected
The huge government stimulus packages during the coronavirus crisis have drained the state coffers. But the government budget deficit has turned out to be markedly lower than feared, among other things because pension return tax revenues have contributed to filling the state coffers. Meanwhile, actual spending under the stimulus packages has been considerably lower than assumed in the original budget. Against this backdrop, we expect the general government budget balance to show a deficit of 2.5% for 2020 and 1.5% for 2021. This means that in both years the government deficit will remain below the 3% threshold of the EU’s Growth and Stability Pact. And as the Danish central bank has topped up the government’s account with the bank in response to the crisis, gross government debt should start to decline again as early as in 2021. This is a clear testament to the fundamental strength of Danish public finances, which also contributes to ensuring a narrow yield spread between Danish and German long yields.
This article first appeared in the Nordea Economic Outlook: The Growth Booster, published on 27 January 2021.
Jan Størup Nielsen, Nordea Chief Analyst
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