In record time the Danish economy has moved from deep economic crisis to a situation entailing a risk of overheating. The fast recovery puts heavy demands on the flexibility of the labour market and requires considerable adaptability in terms of economic policy. The housing market appears to be normalising after a period of very large price increases. But consumer prices have started to rise faster than previously, and there are signs of mounting wage pressures.
From an international perspective, the Danish economy has weathered the coronavirus crisis extremely well. Last year activity “only” dropped by 2.1% compared to the Euro-area average of some 6.0%. Despite a temporary setback in the first months of the year, the relatively strong performance has continued into 2021. Overall economic activity in Denmark now exceeds pre-pandemic levels.
The economic recovery has been driven by a very expansionary economic policy, successful disease control strategies and solid growth in goods exports. This is expected to continue, lifting GDP growth to 3.3% this year. We have thus revised up our 3.0% growth forecast from May. Towards the end of the year and into 2022 it will likely be increasingly difficult to maintain the strong momentum, primarily due to growing labour shortages and because the government will start to tighten economic policy. Against this backdrop, the Danish economy is expected to grow by 2.7% in 2022 and by 2.2% in 2023.
At this juncture, the biggest risk to the Danish economy is that a too rapid upswing will create imbalances. The aftermath of the financial crisis has taught us that the recovery from such imbalances could drag on for a long time.
Strong household consumption of goods
During the coronavirus crisis, Danish consumers spent considerably more on goods. As a result, retail sales increased sharply and have accelerated further after the reopening in early spring. Recent data of Nordea customers’ use of cards indicate that consumer spending on services is also rising fast.
The increase in household spending is partly due to pent-up demand during the lockdowns that is now unleashed after the reopening. At the same time households’ purchasing power has been strengthened by positive real wage growth, low interest rates, rising housing prices and not least the disbursement of frozen holiday pay. Despite the increase in spending, households’ savings ratio still remains well above the historical average.
Also, it is noteworthy that household debt as a percentage of disposable income is largely unchanged despite the surge in housing prices. This is markedly different from the situation ahead of the financial crisis when households’ increased indebtedness had significant repercussions long after the crisis hit.
Households’ large savings buffers will provide a robust foundation for sustained growth in household spending. And the refund of overpaid housing tax of some DKK 14bn will further boost this growth potential. The refund is estimated to relate to just over 700,000 owner-occupied homes. Most of the refund will be disbursed over the next couple of years as the new property valuations are gradually completed.
Denmark: Macroeconomic Indicators, Baseline scenario
|Real GDP, % y/y||2.1||-2.1||3.3||2.7||2.2|
|Consumer prices, % y/y||0.8||0.4||1.4||1.5||1.7|
|Unemployment rate, %||3.6||4.6||3.9||3.2||2.8|
|Current account balance, % of GDP||8.7||8.3||7.5||7.4||7.6|
|General gov. budget balance, % of GDP||4.1||-0.6||0.0||0.9||1.4|
|General gov. gross debt, % of GDP||33.6||42.1||39.3||38.9||37.9|
|Monetary policy rate, deposit (end of period)||-0.75||-0.60||-0.50||-0.50||-0.50|
|USD/DKK (end of period)||6.66||6.08||6.45||6.71||6.77|
Growing goods exports
During H1 2021 the value of total Danish goods exports rose by 7% relative to the year-earlier period. Relative to H1 2019 the increase was 3%, which means that Danish goods exports are at an all-time high. Especially exports of pharmaceuticals, machinery and food products have surged. Moreover, Danish companies benefit from a steady improvement of the terms of trade, which means that prices of Danish export goods rise faster than prices of imported goods.
With the increase in world trade and growing demand in many key export markets, Danish exports look set to rise sharply over the forecast period. The pick-up in exports will also be driven by services exports returning to pre-crisis highs. However, Danish imports are also expected to rise sharply over the coming years and as a result, the current account surplus will likely remain around 8% of GDP.
Strong labour market may pose challenges
In record time the Danish labour market has moved from crisis and rising unemployment to a situation with sharply declining unemployment and an all-time high level of employment. However, on the flip side, a large and rising number of businesses report that they are having trouble recruiting the people they need. Also, there are growing signs of mismatch problems. For example, the number of job vacancies is currently markedly higher than before the coronavirus crisis while the unemployment rate remains slightly higher. Businesses’ mounting difficulties in recruiting labour are also reflected in the fact that more than one out of every three businesses in the manufacturing and construction industries point to labour shortages as a production limiting factor.
The growing labour shortages are beginning to show through in wages. New data from the Confederation of Danish Employers (DA) show that labour costs rose by 3.1% in Q2, which is about 0.5% point higher than before the coronavirus outbreak. Although the relatively high wage increases can be partly explained by technical factors around the reopening of the economy, we expect the average rate of wage increases next year to reach an all-time high since the financial crisis.
With its strong economic foundation the Danish economy should see solid growth in the years ahead.
Jan Størup Nielsen, Nordea Chief Analyst
Soft landing for the housing market
Housing market developments currently attract much attention. According to Eurostat, Danish housing prices rose by 15.3% from Q1 2020 to Q1 2021. This is the second-highest increase among the member states and almost three times the EU average. In addition to strong demand, the surge in housing prices has mainly been driven by exceptionally low supply of housing on the market.
However, recent data suggest that the Danish housing market is heading for a soft landing. The number of homes for sale has risen noticeably, the time on the market has increased slightly and the monthly rate of price increases for all housing types has declined over the summer to the lowest level this year. We expect this gradual cooling of the housing market to continue as the balance between supply and demand improves after the coronavirus crisis. Moreover, moderately rising financing costs and the current high level of prices should dampen housing price growth going forward.
Mainly as a result of the surge in prices earlier this year, the increase in the average price per square metre for single-family houses in 2021 looks set to be just over 12%. Next year, the rate of increase should be 3% and then just 1% in 2023. Note that the much slower price growth should also be seen in light of the changed housing tax rules effective from 1 January 2024.
Prudent fiscal policy
The government’s expansionary fiscal policy has played a key role in helping the Danish economy to weather the crisis. This applies both to the massive aid packages to businesses and the decision to disburse frozen holiday pay to wage earners. With several years of relatively high economic activity ahead of us and a labour market that already shows signs of overheating, we think the time is ripe to start tightening fiscal policy. At the same time it is important that the aid packages are phased out as planned because otherwise they could limit flexibility in the economy.
Danish central bank selling kroner
EUR/DKK still trades on the strong side of the central parity. In order to counter this pressure, the Danish central bank has been selling kroner in the currency market since February. All in all, it has sold kroner for nearly DKK 50bn during that period. However, the bank’s intervention this year should be seen in light of its massive buying of kroner at end-2019 and in early 2020. At that time the bank bought kroner for more than DKK 83bn to prevent an unwanted weakening of the DKK. In our view, the central bank’s ongoing intervention should mainly be seen as a reversal of steps taken previously rather than a precursor to an independent Danish rate cut.
Our baseline scenario is that the central bank will keep its policy rates unchanged until end-2023. But Danish market rates on longer maturities are expected to rise gradually in tandem with the recovery of the Euro-area economy. During this period Denmark’s healthy public finances and large current account surplus will likely continue to underpin a small interest rate differential between Denmark and the Euro area.
This article first appeared in the Nordea Economic Outlook: A new phase, published on 1 September 2021.
Jan Størup Nielsen, Nordea Chief Analyst
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