Monetary policy settings are currently supportive of growth, but will become less so by 2006 as the European Central Bank gradually raises interest rates and Denmark follows suit. Further initiatives to increase labour force participation would help to sustain the upturn and bring employment closer to the government's medium-term target.
Exports and household spending continue to drive the recovery
The first half of 2004 saw a substantial pick-up in exports and continued solid J growth in private consumption after the boom at the end of 2003. While the increase , in demand was largely matched by a huge rise in imports, real GDP grew well above J its potential rate. Short-term indicators point to a continued pick-up in growth in the second half of this year, as confidence indicators have risen substantially (even if there has been some recent reversal in manufacturing) and growth in retail and car sales has been brisk. The labour market has turned for the better after the steady worsening last year, and the standardised unemployment rate now stands at 5 3/4 per cent of the labour force (around 1 percentage point above the structural rate). Wage increases have moderated, reflecting the weaker labour market than in previous years. Consumer price inflation has also remained low, despite significant oil price increases.
Fiscal easing boosts household income
The stimulus from tax cuts implemented at the beginning of 2004 and the spring fiscal package (frontloading tax cuts planned for 2005-07 and suspending Special Pension contributions in 2004 and 2005) is a major driver of growth this year and next. Its main impact is to boost household disposable income. The fiscal easing is expected to push the general government surplus back below 1 per cent of GDP this year, although rising activity and higher employment should help it recover to 1 1/2 per cent of GDP by 2006. After adjusting for the business cycle and certain one-off factors, the structural surplus is projected to remain below the government's target of 1 1/2 to 2 1/2 per cent of GDP over the projection period. A risk to public finances is the restructuring of local governments from 2007, which could involve substantial adjustment costs in 2006 that would be difficult to handle within the spending targets set out in the government's medium-term fiscal framework. Monetary conditions continue to follow euro area developments, with a gradual increase in interest rates projected in 2006 as activity picks up in the euro area. The fiscal stimulus may have pushed Denmark a little ahead in the cycle compared to the euro area, which could make monetary policy there less appropriate for Danish conditions.
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Growth depends on household behaviour and export markets
With accommodative fiscal settings, output is projected to increase by just above 2 1/2 per cent per annum from 2004 to 2006. Private consumption seems to have picked up in the second half of 2004 as households reacted to the fiscal package while continued strong exports due to recovering foreign demand have further boosted activity this year. Household spending and exports should remain strong over the next two years, although some moderation of private consumption growth is projected in 2006 as Special Pension contributions are resumed, cutting into disposable incomes. Business investment may provide more support to growth in 2005 and 2006 as firms seek to expand capacity. The unemployment rate is also projected to fall as the business sector starts to increase hiring. Yet wage and price increases should be moderate as output is expected to remain below its potential level until the end of 2005. The main source of uncertainty is the reaction of households to the extra income from previous policy measures. The more of this they decide to spend, the faster capacity constraints may begin to bite, raising inflationary pressure. The strength of the European recovery generates a further uncertainty associated with the outlook, given Denmark's close economic integration with its European Union partners.
Denmark: Demand, output and prices
2001 2002 2003 2004 2005 2006
Current
prices
billion Percentage changes,
DKK volume (1995 prices)
Private consumption 624.5 0.6 0.8 3.6 3.3 2.4
Government consumption 343.3 2.1 1.0 0.7 0.7 0.8
Gross fixed capital formation 271.0 4.5 0.1 3.6 4.7 5.4
Final domestic demand 1 238.7 2.0 0.7 2.8 3.0 2.8
Stockbuilding (a) 1.3 0.0 -0.4 0.2 0.1 0.0
Total domestic demand 1 240.0 1.9 0.3 3.1 3.1 2.8
Exports of goods and services 592.1 4.8 0.0 4.9 6.0 6.4
Imports of goods and services 506.5 7.3 -0.6 6.6 7.0 7.1
Net exports (a) 85.5 -0.8 0.3 -0.5 -0.3 -0.1
GDP at market prices 1 325.5 1.0 0.5 2.4 2.7 2.6
GDP deflator -- 1.6 2.2 1.9 2.0 2.0
Memorandum items
Consumer price index -- 2.4 2.1 1.2 1.7 2.0
Private consumption deflator -- 2.1 1.8 1.2 1.7 1.9
Unemployment rate -- 4.6 5.6 5.8 5.3 4.9
Household saving ratio (b) -- 0.1 0.3 -0.3 -1.6 -1.3
General government financial
balance (c) -- 1.6 1.2 0.9 1.4 1.5
Current account balance (c) -- 2.0 2.7 3.1 3.1 3.4
(a) Contributions to changes in real GDP (percentage of real GDP in
previous year), actual amount in the first column.
(b) As a percentage of disposable income, net of household consumption
of fixed capital.
(c) As a percentage of GDP.
