Recent Economic and Monetary Trends

USA
GDP in the USA rose by 0.9 per cent from the 2nd to the 3rd quarter. Output growth was thus in step with the preceding quarters. The economy was driven by domestic demand – as has been the case since the onset of the upswing in 2003.

In the aftermath of the hurricanes, a number of monthly economic indicators deteriorated. In September both industrial output and employment fell, and confidence among consumers and in the service sector dropped sharply. If the effects of the hurricanes are disregarded, the underlying drive in the economy was considerable.

The government has granted disaster relief of more than 60 billion dollars to the areas devastated by the hurricanes. Over the next few quarters more funds will be channelled into reconstruction. This supports the impression of temporary effects with slightly lower economic growth in the 2nd half of 2005 and slightly higher growth in 2006 as the reconstruction activities commence. [2] Overall the US economy remains robust. The most recent consensus estimates for GDP growth in 2005 and 2006 are 3.6 and 3.3 per cent, respectively.

Disaster relief and reconstruction aid imply that the budget deficit will deteriorate. The hurricanes had only a limited impact on the deficit in the recently concluded fiscal year 2004- 05, in which the federal budget deficit improved by almost 100 billion dollars from 3.6 per cent of GDP the year before to 2.6 per cent, owing to an improved economic climate. The deficit is still large, considering that the economy is in an upswing.

In the short term, the high energy prices give some uncertainty. They may have an impact on the underlying formation of wages, prices and expectations, and also undermine growth in consumers' disposable incomes and raise business enterprises' costs. The Federal Reserve monitors these risks, and currently expectations of medium-term inflation remain stable at a low level, cf. the above discussion of the financial markets.

Japan and China
The economic development in Japan is more promising than it has been for a long time. GDP grew by 0.4 per cent in the 3rd quarter and was 3 per cent higher on an annual basis, cf. Chart 7. Growth was driven by domestic demand, which was broadly based on both private consumption and investments. A number of key indicators point to a sustained improvement of the economy. The labour market is definitely picking up; for instance, nominal wages are rising for the first time in several years, cf. Chart 7. In the same way, some measures of lending show positive growth rates, and prices for property in certain areas of Tokyo have begun to rise after falling for around 15 years. Corporate earnings are high, and the banks' bad loans have been reduced substantially. The prerequisites to sound economic development are therefore present, and GDP growth of, respectively, 2.2 and 1.9 per cent is expected in 2005 and 2006 (consensus estimates).

The improvement in the economy has not yet reversed the development in consumer prices. Core inflation, measured as the rate of increase in consumer prices excluding fresh food, was -0.1 per cent in September. The Bank of Japan expects the decline in consumer prices to cease within a number of months. For almost 5 years, monetary policy has been conducted according to a quantitative measure of the banks' deposits with the central bank so that the short-term interest rate has de facto been zero. According to the Bank of Japan, this type of monetary policy will be maintained until consumer prices excluding fresh food stop falling on a sustainable basis.

Output in China also increased substantially in the 3rd quarter. GDP growth was almost 10 per cent year-on-year, and the annual growth rate for industrial production was in the range of 15 per cent, cf. Chart 7. The massive growth rates are especially driven by exports and should be viewed against the background of the gradual transition to a market economy and greater integration into the global economy. China is a low-income country and thus has high growth potential.

China 's economy influences the global economy in many areas. This impact is a relatively new phenomenon and has only really materialised within the last 5 years, as more and more foreign enterprises have set up business in China . First and foremost, the economy is very open, which has led to greater competition, cheaper goods and increased global trade, particularly within Asia . In addition, the opportunity to relocate production has undoubtedly influenced wage formation in other countries. In parallel with the increase in growth, demand for commodities has risen – and so have prices. Overall, the integration entails large economic gains, not only for China , but for the entire global economy, even though it also requires considerable adaptability of other countries in the short term.

Euro rea
After a year with sluggish development, economic activity in the euro area accelerated in the autumn. GDP grew by 0.6 per cent from the 2nd to the 3rd quarter. Demand statistics are not yet available, but growth has apparently to a large extent been driven by increased exports. For the full year, GDP growth is expected to be 1.3 per cent in 2005 and 1.7 per cent in 2006 (consensus estimates).

The main problem in relation to the euro area's economy is domestic demand, which particularly in Germany , but also in Italy , has grown only moderately for some time. In Italy the situation is aggravated by a large government deficit and considerable deterioration of competitiveness in recent years, cf. Chart 8. Like Italy , Germany is burdened by a large government deficit. On the other hand, the export sector has benefited from improved competitiveness. Export performance has been strong, and the German economy is clearly split in two. It is a paradox that the impulse from the export sector has not been transmitted to the rest of the economy, which has room for improvement after many years of low growth. This mechanism has previously kick-started not only a German, but also a European, upswing.

The monthly economic indicators from the autumn point to a continued split in the euro area economy with a strong export sector and weak domestic demand. Industrial production and business confidence have been rising, which is in accordance with the global tendencies in trade and manufacturing industry. The Ifo index, which measures broad confidence in the German business sector, rose substantially, and both business expectations for the future and the view of the current situation improved. Retail sales have developed more unevenly and have fallen in Germany , among others.

The rising energy prices led to higher inflation during the autumn. In October, the Harmonised Index of Consumer Prices, HICP, was 2.5 per cent higher than in the same month of 2004. This is above the ECB's intermediate target of inflation close to, but below, 2 per cent. Sluggish domestic demand means that rising energy prices, which undermine disposable incomes, are highly inopportune for the euro area.

Underlying inflation to a greater extent reflects subdued economic development, cf. Chart 10. Stated as the increase in HICP excluding energy and unprocessed food, core inflation has fallen in 2005. So far there have been no clear indications of second-round effects of the energy price increases. Unemployment was 8.4 per cent in September. This is above the OECD estimate of structural unemployment, which is 8 per cent. This high level reflects rigid labour markets. At approximately 2 per cent, the rate of wage increase is moderate.

The government platform for the new German government has been presented. It points to fiscal-policy consolidation, which will also ensure conformity with the Stability and Growth Pact. Consolidation is to be achieved via VAT and tax increases, among other measures. It is also the intention gradually to raise the retirement age from 65 to 67 years in the period 2012-35.

Both Denmark 's Scandinavian neighbour economies show solid upswings. Growth is high, the labour markets are expanding, and inflation is low.

In Norway consumer prices rose by 1.2 per cent in October measured by the KPI-JAE index, which excludes energy and taxes. This is below the inflation target of 2.5 per cent. In November, Norges Bank raised its sight deposit rate by 0.25 per cent to 2.25 per cent. The central bank indicates that the strategy of infrequent and small interest-rate increases will continue, and also expects the inflation target to be met in 2008.

In Sweden consumer prices rose by 0.8 per cent in October measured by the increase in the UND1X index, which excludes taxes and price effects from interest-rate changes. This is below the target zone of 1-3 per cent. Since June, when the repo rate was lowered by 0.5 per cent, Sveriges Riksbank has kept the rate unchanged at 1.5 per cent, and the Swedish krona has weakened by around 4 per cent vis-à-vis the euro. The government has proposed a fiscal-policy relaxation in the range of 1 per cent of GDP in 2006.

Fluctuations in capital flows between Denmark and abroad may cause undesired fluctuations in the exchange rate, which are contained by Danmarks Nationalbank via intervention in the foreign-exchange market. In September and October, Danmarks Nationalbank net sold currency for a total of kr. 13 billion in order to stabilise the krone.

Since mid-September, the interest rates in the money and capital markets have been increasing in step with European interest rates. In the money market, the spread between the 12- and 3-month interest rates widened from approximately 10 to just over 35 basis points. One reason is that the market participants expect official interest rates in the euro area to be raised during the coming year. The yield on 10-year Danish government bonds rose from 3.07 per cent in mid-September to 3.53 per cent in mid-November.

During the past six months, the 10-year yield spread vis-à-vis Germany (maturity-adjusted) has been weakly negative. The yield spread has fluctuated in the range from 0 to ‑10 basis points.

The marginal rate in the ECB's weekly liquidity tenders has been just under 10 basis points below Danmarks Nationalbank's lending rate in the period, while the spread between the lending rate and the ECB's minimum bid rate has remained unchanged at 15 basis points. Danmarks Nationalbank's lending rate was 2.15 per cent in mid-November, while the discount and current-account rates were 2 per cent.

THE DANISH ECONOMY

Overall
The Danish economy is in a broadly based upswing. Output, employment, consumption and investments all point to an upturn. Unlike previously, exports are now growing so fast that external trade also makes a net contribution to economic growth. There are sound current-account and government budget surpluses, and the rates of wage and price increases match those of Denmark 's trading partners.

The upswing is founded in a number of factors. The upturn started in mid-2003, and came after a couple of years with subdued Danish and foreign growth. Since then the global economy has grown considerably, particularly in 2004, but also in 2005. Financial conditions are expansionary. In addition, the upswing can be seen as a result of many years' prudent economic policy. Among other things, labour-market structures have been improved on an ongoing basis, albeit at a slower pace in recent years. Last but not least, Danish enterprises seem to have been able to adapt and maintain their competitiveness.

In spite of the strong point of departure, the current buoyancy of the economy also calls for caution. This is illustrated by experience from the Netherlands , which – like Denmark – has a relatively well-functioning labour market. In the late 1990s, the Dutch economy saw a number of years with high growth, cf. Chart 14. The housing market boomed, and the current account and government budgets showed surpluses. Unemployment fell to a low level without any immediate impact on the rate of wage increase. Only at a late stage, around the year 2000, did wages and prices begin to accelerate strongly. Since then the economy has been ailing and has had difficulty in regaining competitiveness, cf. Chart 8. Several factors triggered the downturn. Firstly, the strength of the upswing was underestimated and consequently spare capacity was overestimated. ^[5] Secondly, fiscal policy was not sufficiently tight, and in the subsequent backlash it was therefore necessary to introduce tightening measures. During the upturn, fiscal policy was designed so that part of the income that exceeded expectations in the budget automatically triggered tax cuts. Experience from the Netherlands shows that strong development in wages and prices can set in unexpectedly and with some delay if demand is sufficiently strong.

Economic activity, the labour market and government finances
Economic growth was strong in the 1st half of 2005. Output in GDP terms in the first six months of the year was 2.6 per cent higher than in the same period of 2004. From the outset, the upswing has primarily been driven by domestic demand. This was also the case in the first six months of the year, but the negative contribution from net exports has now ceased.

Private consumption has been a significant driving force during the last year, with quarterly real growth rates in the range of 1 per cent or higher. Consumption has fundamentally been stimulated by lenient financial conditions, falling unemployment, a strong housing market and growth in real incomes. This has been broadly reflected in purchases of cars and in retail trade. This development should, however, also be viewed in combination with a relatively weak trend in private consumption in the period 1999-2002, when the savings ratio increased. National accounts data for the 3rd quarter is not available, but the development in car sales and retail trade points to a slight dampening after strong growth in the 2nd quarter. However, some fluctuation is often seen from one quarter to another, and the underlying conditions still support consumption. Consumer confidence is very high, and the housing market has not shown any signs of a slowdown – on the contrary. The statistics from the Association of Danish Mortgage Banks show that in overall terms for the whole country prices for single-family and terraced houses rose by 17.8 per cent year-on-year in the 3rd quarter, and rose most in the Greater Copenhagen area.

Investment activity is clearly picking up. The upswing in the property market has stimulated residential investments, but investments in plant and equipment in the business sector have also increased substantially since the start of the upswing. While growth in private consumption was weak in 1999-2002, investments in plant and equipment were also strong during that period. The investment ratio, i.e. investments in plant and equipment as a ratio of GNP at constant prices, has been rising over the past decade. This points to ongoing rationalisation.

So far the domestically driven upswing has especially affected the service-oriented sectors and construction, and only to a lesser extent manufacturing industry. In service and construction, confidence is very high and has been increasing since 2003, cf. Chart 15. Industrial production has developed moderately, and employment has been falling. The background is the structure of the upswing so far, but possibly also that it is easier to streamline manufacturing, which is necessary in view of the competition from low-wage countries. Exports have developed favourably, particularly in 2005, and judging from the rising tendency shown by industrial confidence, the upswing is now broadly based.

Unemployment has been falling since the end of 2003, when it stood at approximately 185,000. In September, unemployment was just under 152,000, or 5.5 per cent of the labour force. The number of people in activation schemes, who do not officially count as unemployed, is also low. At the time of going to print there were no reliable employment figures for the 3rd quarter. Assessed on the basis of the confidence indicator for building and construction, the demand for labour in this sector is unusually high.

The rate of wage increase is still moderate. However, wages tend to react with a time lag, so the current development is more likely to reflect the business cycle in previous years, and technical pension measures have also temporarily contributed to a lower rate of increase. There can be no doubt that the ongoing labour-market reforms since 1993 have reduced structural unemployment, but the precise level is not known. However, while unemployment during the most recent upswing in the 1990s fell from a high level, this time unemployment is at a low level from the outset, and is rapidly declining. It is essential to stable development in the Danish economy that the labour force is increased in the future and that a fair balance is struck between the supply of and demand for labour.

Government consumption in real terms grew by 1 per cent in the 1st half of 2005 compared to the same period of 2004. These figures are not final and are subject to uncertainty, but indicate that as in 2004 growth will exceed the government's target for 2005, unless there is a significant slowdown in the 2nd half of 2005. In view of the current upswing, it is extremely important that fiscal policy is not expansionary, but rather structured to stabilise the economy.

The government budget surplus was 1.7 per cent of GDP in 2004, and in August the Ministry of Finance expected an improvement to 2.5 per cent in 2005. The surplus primarily reflects the upswing, as well as extraordinarily high revenue from the North Sea and taxation of pension yields. If the cyclical effects and the extraordinary revenue are deducted, the balance remains virtually unchanged, provided that the planned expenditure level is observed.

Balance of payments and foreign trade
A substantial current-account surplus is anticipated in 2005. In the first nine months of the year, the surplus was almost kr. 50 billion, of which kr. 20 billion in July-September. It therefore seems reasonable to conclude that the surplus will be somewhat larger than the preceding year's level of kr. 33 billion. The balance-of-payments statistics were restructured at the turn of the year, so caution should be exerted when comparing with previous years, particularly in relation to service items.

A large and increasing proportion of the current-account surplus is attributable to trade in services, especially sea freight, cf. the article on pp. 41ff, which analyses shipping and the Danish economy. Danish shipping has expanded in recent years. In the last few years the sector has also benefited from high freight rates. Like oil prices, they have been boosted by high global growth and trade. Since Denmark is a net exporter of oil, higher oil prices have also made an extra contribution to the external trade surplus. However, part of the revenue is paid out as dividends to non-residents with ownership interests in e.g. Dansk Undergrunds Consortium. This influences the current account in the opposite direction.

The large and rising current-account surplus indicates that competitiveness is good, but it does not imply that the capacity limit of the economy has shifted notably. In the 1990s, initial pressure problems coincided with a current-account deficit, but now they are likely to emerge at a time when there is a substantial surplus. Furthermore, the current-account surplus does not automatically shield the economy against any subsequent cyclical downturn.

As regards trade in goods, the value of manufactured exports has been rising since mid-2003, cf. Chart 16. This increase has accelerated in 2005, and export order books are at a high level. Both the reversal in 2003 and the acceleration in 2005 accord with the upturn in manufacturing and trade in other countries.

The Danish upswing has only to a limited extent been reflected in the trade balance, cf. Chart 16. The primary reason is the surplus on energy exports. If this is disregarded, the deterioration in the trade balance excluding energy in 2004 rather reflects that the Danish economy has been running at full speed and that imports of goods have increased. However, in 2005 the development in exports has been sufficiently strong to reverse the downward tendency.

The reversal of the trade balance excluding energy is remarkable at a time when the Danish economy is expanding significantly while Denmark's largest trading partner, the euro area, is struggling. Growth in other export markets, including the Anglo-Saxon countries and Scandinavia , has been high, but the development also points to an underlying sound competitiveness. For many years, wage increases have been higher than abroad, but this has been set off by stronger development in productivity, cf. e.g. Chart 8. In addition, the terms of trade have improved. Some imports, such as textiles and electronics, have become cheaper, and cheap goods from emerging markets are increasingly reaching the Danish market. Increased competition from emerging markets also exerts pressure on the Danish business sector, but so far it has been able to adapt. A relatively flexible economy, e.g. with easy access to adjust the labour force, may have facilitated this process.

Prices and wages
Danish consumer prices have increased at a faster rate in 2005. In October consumer prices were 2.0 per cent above the level in the same month of 2004. Measured by the increase in the Harmonised Index of Consumer Prices, HICP, inflation was 1.9 per cent, cf. Chart 17. As in other countries, in particular the higher energy prices have exerted upward pressure on consumer prices in general.

Inflation in Denmark was lower than in the euro area in October, but has otherwise been close to the euro area level in the autumn. Unlike in the euro area, core inflation in Denmark has been increasing in 2005, cf. Chart 17.

The weights for the IMI index have been updated, cf. the article on pp. 27ff. IMI is a measure of the market-determined development in Danish prices for goods and services and can be seen as an index of underlying inflation in Denmark. IMI has been unusually low in recent years and was ‑0.5 per cent in October. This reflects that the rising energy and import prices have not passed through to consumer prices, and have coincided with receding wage increases.

  Wages in the private sector (covered by agreements with the Confederation of Danish Employers) rose by 2.8 per cent in the 3rd quarter, according to the Confederation of Danish Employers. This is slightly more than in the 2nd quarter, but still moderate.

Wage increases in the manufacturing sector have for some time exceeded those abroad, cf. Chart 18. In 2005, the rate of increase has been in step with abroad, but still higher than in the euro area. Manufacturing is subject to international competition, and in addition to rationalisation gains, decentralised wage formation may contribute to a future rate of wage increase that reflects the competitiveness of the individual enterprises. However, this still requires a sufficient and appropriate supply of the various types of labour. This may take some time, and the upswing must not accelerate too fast and jeopardise the opportunity to reduce unemployment permanently.