Recent Economic and Monetary Trends

This review covers the period from late November 2006 to the middle of February 2007.

THE INTERNATIONAL FINANCIAL MARKETS

The global economy is still performing well, with sound growth in both the USA and the euro area. Many Asian economies, particularly China, are expanding strongly. The upswing in Japan is also sound. The market expects growth to continue more or less unabated throughout the year.

The US dollar weakened against the euro up to the turn of the year, cf. Chart 1. In mid-February, the exchange rate was 1.30 dollars per euro, which is a weakening of 10 per cent from the level one year before. The yield spread between short-term interest rates in the USA and the euro area has narrowed in the period under review as the European Central Bank, ECB, has raised its interest rates, while the Federal Reserve has held the fed funds target rate unchanged since May 2006. In addition, the growth differential between the two areas has narrowed.

The 10-year US government bond yield has declined from the level in the summer and has been just over 4.5 per cent since the autumn, but with a rising tendency since the turn of the year, reflecting positive economic indicators for the USA. With the fed funds target rate unchanged at 5.25 per cent, the US yield curve is still falling. This indicates dampened medium-term inflation expectations in the markets. The yield on the 10-year German government bond has generally mirrored the development in the long-term US yield, but at an approximately 0.75 percentage point lower level.

The oil price peaked last summer at more than 75 dollars per barrel (Brent). Since then, the price has dropped to around 55 dollars per barrel in mid-February, cf. Chart 2. The price drop reflects lower demand as a consequence of a relatively mild winter, combined with sustained high output. Moreover, there are ample oil stocks. The price dive dampens global inflation and probably also inflation expectations, and improves the international growth prospects.

With the exception of oil and copper, commodity prices are still rising. The positive growth prospects have contributed to a sustained upward trend in the benchmark stock indices.

INTERNATIONAL ECONOMIC BACKGROUND

USA
In the USA, 4th quarter growth exceeded expectations, with GDP at constant prices rising by 0.9 per cent quarter-on-quarter. Growth was driven by higher private consumption, while residential investments fell sharply, as in the preceding quarters. This reflects the general slowdown in the US housing market, cf. Box 1.

DAMPENING OF THE US HOUSING MARKET	Box 1
House prices in the USA, as in many other OECD countries, have risen substantially since the mid-1990s, but now there are clear indications of a slowdown in the US housing market. Most recently the price index has flattened out, cf. Chart 3, while residential investments and the more long-term expectation indicators have fallen significantly. Many recent indicators point to stabilisation of the housing market.
HOUSE PRICES AND THE HOUSEHOLDS' SAVINGS RATIO IN THE USA	Chart 3
Note: " House prices" is the median price of existing housing. Source: EcoWin.
The rising house prices have been a key driver of the US upswing and have contributed to the decline in the household's savings ratio, which is now negative. With large capital gains on homes and stocks, a given level of wealth can be achieved with lower savings from income. The question is whether the slowdown in the housing market is temporary or more permanent, and the extent to which the slowdown will spread to the rest of the economy. So far, the flattening of house prices has not been reflected in private consumption, partly because homeowners still have large home equity portfolios that can be mortgaged, but in the most recent quarters residential investments have declined. In all probability there will be a " soft landing" for the US economy, with continuing dampened growth. The Federal Reserve has not changed the fed funds target rate since May 2006, partly in view of the sluggish housing market. The slowdown in the US housing market reduces capital gains on the housing stock, which may increase the households' savings ratio. This will temporarily dampen economic growth in the USA. The direct effect from one country's housing market to other countries' housing markets is limited. In this respect the housing market differs from e.g. the stock and bond markets. The effect of a subdued US housing market on the global economy is transmitted via lower domestic demand in the USA and via interest rates.

Many new jobs continued to be created in the USA, mainly in the service sector, while employment in the construction sector remained unchanged. Since the labour force expanded more than employment, unemployment rose a little to 4.6 per cent in January. Due to the tight labour market, wage increases were higher at 3.5-4.0 per cent.

Inflation, measured as the increase in the index of consumer prices, fell considerably in the autumn, mainly as a result of lower energy prices. Core inflation, which excludes energy and food, has also fallen in recent months, to 2.6 per cent in December.

The fed funds target rate has been unchanged for the last nine months. According to the press release from the FOMC meeting on 31 January, there is assessed to be some inflationary pressure in the economy, but whether a monetary-policy tightening is required will depend on the economic indicators released in the near future. The markets expect the fed funds target rate to remain unchanged throughout 2007.

Japan and China
The upswing in Japan has proved to be robust. Growth has mainly been driven by exports. Especially exports of cars and IT have developed positively. Employment has risen in most recent quarters.

It remains uncertain whether Japan has left falling prices behind it. Consumer price inflation has been marginally positive for the last year or so, but core inflation remains negative. The Bank of Japan abandoned its zero-interest-rate policy in July 2006, raising its official interest rate by 0.25 per cent, but the low inflation makes it difficult to normalise monetary policy, and the interest rate has not been raised further.

The Chinese economy continued its strong expansion throughout the year, with growth exceeding 10 per cent p.a. The growth in investments has receded, however, which may indicate that the political measures such as higher interest rates, higher reserve requirements for banks and further control of investment projects, have begun to make an impact. The investment ratio remains very high at approximately 40 per cent of GDP, according to the official data. However, some analysts assess the real figure to be considerably lower, so that the risk of a substantial decline in investments has also diminished.

The Chinese currency, the renminbi, has appreciated by just over 6 per cent against the dollar since the summer of 2005. The renminbi is managed in relation to a basket of currencies that includes the euro and the Korean won, both of which have appreciated against the dollar. The basket also includes the Japanese yen.

In December, China lifted the last restrictions on foreign banks' entry into the Chinese market, in accordance with its WTO (World Trade Organization) obligations. Considerable foreign investments have already been made in the Chinese banking sector.

Europe
Following a subdued 3rd quarter, GDP growth in the euro area picked up again in the 4th quarter, to 0.9 per cent against the preceding quarter. Growth is increasingly driven by private consumption and is thus more broadly based than at the start of the upswing. On average, the forecasts indicate that growth is expected to continue in 2007 at a level around or slightly above the potential of approximately 2 per cent p.a. Neither the strengthening of the euro against the dollar nor the German VAT increase from the turn of the year are thus expected to brake the upswing, but at most to dampen growth.

The euro area labour markets continue to improve, cf. Chart 4. Employment and employment expectations are rising in both the manufacturing and service sectors, and unemployment has been declining steadily for the last few years, to 7.5 per cent in December 2006. Unemployment in Germany was 9.5 per cent in January, which is the lowest level for five years. To drive unemployment even further down on a more permanent basis additional labour-market reforms to introduce greater flexibility are required.

The cyclical upswing has improved government finances in the euro area where all the large member states except Italy are expected to fulfil the requirement of a deficit not exceeding 3 per cent of GDP in 2007. Contrary to expectations, Germany already met this requirement in 2006.

The drop in the oil price from the summer of 2006 ensured that consumer price inflation in the euro area fell below 2 per cent in the 2nd half of 2006. In January, the rate of price increase was 1.9 per cent. Initially the German VAT increase at the turn of the year, cf. Box 2, has thus only partly been reflected in prices. Data for core inflation in the euro area in January is not yet available, but in Germany core inflation was 1.5 per cent in January 2007, compared to 1.1 per cent in December 2006.

On 7 December, the ECB raised its minimum bid rate by 0.25 per cent to 3.5 per cent. The underlying considerations were that the higher growth and improved labour-market conditions may lead to a higher wage-increase rate, which augments the risk of higher inflation in the medium term. In addition, the growth in the money stock is high. In the assessment of the Governing Council, monetary policy remains expansionary after the increase, and the market expects a further interest-rate increase in March. 

The UK economy is still performing well, growing by 3.0 per cent in the 4th quarter relative to the year before. Consumer prices rose by 2.7 per cent p.a. in January. During the last year inflation has exceeded the government's target of 2 per cent p.a. At the same time, housing prices have accelerated, rising by an annual rate of almost 10 per cent towards the end of 2006, which is twice the rate at the beginning of the year. Against this background, the Bank of England raised the official bank rate at the beginning of November and again in mid-January, to 5.25 per cent. The market expects further interest-rate increases during 2007. In the past year sterling has weakened by nearly 4 per cent against the euro.

The Norwegian and Swedish economies are both expanding strongly. In both countries inflationary pressure is rising moderately, albeit from a low level. The prospect of a medium-term price-increase rate that exceeds the inflation target has led the central banks to continue to tighten monetary policy. Sveriges Riksbank raised the repo rate by 0.25 per cent in mid-December and again in February, to 3.25 per cent. Norges Bank increased the sight deposit rate by 0.25 per cent in mid-December and again at the end of January 2006, to 3.75 per cent.

The new Swedish government plans a major restructuring of Sweden's economic policy. It envisages tax cuts via an employment allowance and a tighter labour-market policy, with a view to increased incentives to seek employment. Other plans include compulsory membership of an unemployment fund, a gradual reduction of the degree of compensation as the period of unemployment lengthens, and a higher share of own financing. Furthermore, the number of people on activation schemes is to be reduced.

At the turn of the year Slovenia adopted the euro and thus became the 13th euro area member state. Within a few days after New Year the national banknotes and coins had been replaced by euro banknotes and coins, and after only a few weeks virtually all transactions in Slovenia were in euro.

Over the past six months, the Slovakian currency, the koruna, has appreciated by almost 10 per cent against the euro and the exchange rate has approached its upper limit in ERM II. Interest-rate increases have amplified the increase in the exchange rate. This development reflects a monetary-policy dilemma for Slovakia, since both an exchange-rate target and an inflation target are pursued. Slovakia plans to adopt the euro on 1 January 2009, and by then it must fulfil the requirements of the Maastricht Treaty in respect of e.g. exchange-rate stability and inflation. The average annual increase in Slovakian HICP over the last 12 months has been 4.3 per cent, which is considerably above the present criterion value of 2.9 per cent.

DANISH MONETARY AND FOREIGN-EXCHANGE CONDITIONS

Since November the Danish krone has been stable vis-à-vis the euro at a level close to its central rate in ERM II of 7.46038 kroner per euro. In the last three months Danmarks Nationalbank has not intervened in the foreign-exchange market. At the end of January, the foreign-exchange reserve was kr. 173.7 billion.

In response to the ECB's interest-rate increase, Danmarks Nationalbank raised the discount rate and the current-account rate by 0.25 per cent to 3.5 per cent with effect from 8 December 2006. Danmarks Nationalbank's lending rate and the rate of interest on certificates of deposit were also raised by 0.25 per cent to 3.75 per cent.

In May 2007, the maturity of Danmarks Nationalbank's monetary-policy loans and certificates of deposit will be reduced from 14 to 7 days. The change is intended to curb the large fluctuations in the day-to-day interest rate that can occur in periods when changes in interest rates are expected, cf. the description on p. 23.

The long-term yield spread to Germany has narrowed since the autumn, and in recent months the Danish 10-year government bond yield has mostly been slightly below the equivalent German yield. 

The development in the financial balances reflects the sustained high level of activity in the Danish economy. Growth in lending by banks and mortgage-credit institutes to households has receded a little in recent months, but remains high, with growth in December of around 12 per cent against the preceding year.

The narrowing of the spread between short-term and long-term interest rates means that adjustable-rate loans make up a decreasing share of new lending by mortgage-credit institutes. These loans now constitute less than half of all new loans. In stock terms, adjustable-rate loans accounted for around half of the outstanding mortgage-credit loans at year-end. Deferred-amortisation loans continue to gain ground and now constitute more than one third of the outstanding mortgage-credit loans.

Besides banks and mortgage-credit institutes, the households borrow from consumer-credit and charge-card companies. Statistics Denmark compiles statistics for lending via charge accounts and charge cards, as well as unsecured cash loans not linked to charge accounts or charge cards. Both types of lending have been increasing over time, but the overall growth in recent years has fallen below the growth in the banks' lending. Unsecured cash loans and loans from consumer-credit and charge-card companies total approximately kr. 15 billion and thus constitute only a small, and declining, share of the banks' lending to households, cf. Chart 5. No current statistics are available for the lending rates on unsecured consumer credit, but surveys show that the interest rates vary considerably. Interest rates exceeding 20 per cent p.a. are not uncommon.

Covered bonds
On 6 December 2006, the Minister for Economic and Business Affairs submitted the draft bill on covered bonds for consultation. The purpose of this legal amendment is to make it possible for banks to issue covered bonds, and to allow mortgage-credit institutes and Danish Ship Finance to continue to issue covered bonds. The act is expected to come into force on 1 July 2007.^[1]

The bill is based on the new capital-adequacy rules, known as Basel II, that have been implemented in the EU as amendments to the Capital Adequacy Directive^[2] and Credit Institutions Directive^[3]. The provisions of the Directives specify the types of assets that are eligible as collateral and the LTV (loan-to-value) limits to be observed if a bond issuer is to be authorised to issue covered bonds. For housing loans, an LTV limit of 80 per cent must be observed on an ongoing basis. This is in contrast to the current rules for Danish mortgage-credit bonds, where the limit must only be observed at the time that the loan is granted. If, for example, house prices fall so that the LTV limit of 80 per cent is no longer observed, the bond issuer must immediately supplement the assets pledged as collateral for the covered bonds issued, e.g. with government bonds.

For credit institutions subject to capital requirements, there is an incentive to invest in covered bonds rather than other bonds issued by credit institutions since the capital requirements for covered bonds are lower. The price of covered bonds can therefore be expected to be slightly higher than for equivalent bonds that are not covered bonds.

If passed, the act will put the banks on an equal footing with the mortgage-credit institutes in terms of issuing covered bonds against mortgage-credit loans as collateral. The aim is to give Danish banks the same opportunities to use this type of financing as their foreign competitors. There is no direct link between the bank's costs of financing the issue of covered bonds and the terms and conditions for the underlying mortgage-credit loans granted to the bank's customers. The interest-rate margin will depend on the competition in the market.

Covered bonds can underpin financial stability as a stable means of financing for loans against real property as collateral, thereby more appropriately covering the banks' large deposit shortfall.

In future, mortgage-credit institutes will be able to issue covered bonds, covered bonds that are also mortgage-credit bonds, and conventional mortgage-credit bonds, i.e. bonds that are not covered bonds. The bill thus promotes enhanced competition between Danish financial institutions.

The bill proposes to allow credit institutions to issue covered bonds using two different models. Under the first model, the existing limitations apply, i.e. a maximum term of 30 years and a maximum of 10 years' deferred amortisation. In this case, LTV at the time of granting the loan and for the loan's duration must not exceed 80 per cent for loans for residential properties, which account for the largest share of loans against real estate as collateral. The second model imposes no limitations on terms and redemption profiles, and for residential properties the upper limit is reduced to 70 per cent at the time that the loan is granted. From 1 July 2009, this limit will be raised to 75 per cent. For these loans too, the maximum current LTV will be 80 per cent.

The ongoing observance of an LTV of maximum 80 per cent will help to ensure that covered bonds are extremely secure bonds with a very low credit risk and thus a low interest rate compared with other bonds. However, if house prices fall abruptly on a downturn in the economy, considerable additional collateral may be required, which the credit institution will have to transfer from its other assets or buy for borrowed funds in order to maintain its status of issuer of covered bonds. This may undermine the general strength of the credit institution in a situation where the economy is already declining and earnings are squeezed, which in turn may weaken financial stability. Lowering the limit to below 80 per cent when the loan is granted will thus make it easier for credit institutions to observe the Directive's requirement of a current maximum LTV of 80 per cent.

Previous amendments to the framework conditions for home financing have affected owner-occupied housing prices. It is for example assessed that the introduction of deferred-amortisation loans in the autumn of 2003 contributed to strengthening an already buoyant market. The present bill is not expected to have any significant impact on housing demand among households. A reduction of the LTV limit from the current 80 per cent for loans financed by covered bonds to, initially, 70 per cent for residential properties will entail a need for a larger share of secondary financing when a home is purchased than is the case today, presumably at a higher rate of interest. On the other hand, the possibility to extend the term of the loan for homeowners who do not require deferred amortisation would help to reduce the monthly payment on a housing loan.^[4]

THE DANISH ECONOMY

The strong upswing has continued unabated. Not only government finances, but also the balance of payments, show a large surplus, so that the current upswing rests on a sound structural foundation, even though the pressure on the labour market is mounting. Via excessive wage increases and a loss of competitiveness, this may in the long term undermine the sound basis for the boom in the economy. At the same time, fiscal policy is marginally expansionary and thus does not contribute to dampening overall demand in the economy.

With quarterly real GDP growth of 0.7 per cent, there was still sound growth in the 3rd quarter, even though it fell short of the two preceding quarters. Growth was driven by investments, including stockbuilding, while private consumption receded a little. The indicators point to sustained sound growth again in the 4th quarter.

In 2007, a shortage of labour and the resulting capacity pressure will put a damper on growth. This dampening is reinforced by Danmarks Nationalbank's interest-rate increases by a total of 1.6 per cent since 2005, as well as the slowdown in the housing market. Long-term interest rates have also risen. On the other hand, continued high growth in disposable incomes can be expected, and the level of activity among Denmark's trading partners is high, which benefits exports.

Balance of payments, foreign trade and government finances
In the last quarter of 2006 the current-account surplus was just over kr. 6 billion, which is less than half the surplus in the same period of 2005. For the full year, the current-account surplus was kr. 40 billion, compared with kr. 59 billion the year before.

The decline is predominantly attributable to a reduction of the trade surplus. Net revenue from marine freight was just over kr. 1 billion lower than one year before, while expenses for bunkering, most of which relate to marine freight, rose by kr. 1.5 billion. The elimination of the external debt means that Denmark has positive wage and investment income from abroad, and the surplus on this item is increasing.

Manufactured exports rose throughout the year. The sustained growth in manufactured exports shows that the increased pressure on domestic capacity has not yet squeezed exports to any significant degree. The growth in manufactured exports was, however, lower than the growth in imports in the recipient countries, so Denmark's market shares were receding. Agricultural exports were also high. On the other hand, imports for consumption continued to expand, and after a period of stagnation imports by the business sector began to rise.

The government's net cash surplus was kr. 93 billion in 2006, equivalent to around 5.7 per cent of GDP, compared with almost kr. 80 billion in 2005. The large surpluses are to a certain extent cyclically determined, and also result from revenue that is predicted to lapse in the long term. This e.g. applies to the revenue from taxation of North Sea oil and gas production, which is at its peak in current years, also boosted by high oil prices.

To ensure the stability of the Danish economy, the medium-term expenditure strategy should be maintained so that extraordinary government surpluses are not used for permanent service improvements or tax cuts, but solely to reduce debt. In the medium term the ageing of the population means that the demand for services produced by the public sector will grow substantially, thereby putting government finances under pressure. The recently adopted welfare reform, cf. Box 3, combined with further reduction of the debt and the resulting interest savings, will make Denmark well-prepared for the demographic changes. The key challenge will still be to ensure a sufficiently large labour force.

Housing market
The housing market slowed down towards the end of 2006. The annual growth in cash prices remains high, but in the 4th quarter prices were flat, the number of sales declined, and the number of homes on the market rose significantly. In more and more cases, the price had to be reduced before a sale could be effected. According to the statistics from the Association of Danish Mortgage Banks, cash prices for single-family and terraced houses in the 4th quarter were 18.5 per cent above the level one year before, but there were considerable regional differences. Prices in the areas that previously saw the largest increases have reacted most strongly to the slowdown. In Greater Copenhagen cash prices for both single-family and terraced houses, as well as owner-occupied flats, fell from the 3rd to the 4th quarter.

It is still uncertain whether there is an actual downturn in the housing market or whether the price-increase rate has merely dampened. In view of the currently very strong Danish economy the latter is more likely to be the case for the housing market overall. In certain regions, downward price correction cannot be ruled out, however.

The slowdown in the housing market is attributable among other things to higher interest rates, mainly at the short end of the yield curve. Particularly in the Greater Copenhagen area there also seems to be a shift in expectations concerning the future development in housing prices. In recent years a buoyant market has been underpinned by expectations of further increases, so that the purchase of a home has also been seen as an opportunity for a, usually untaxed, capital gain. This meant that some existing homeowners purchased a new home before the old one had been sold and therefore for a period had two or more homes. To some extent the mood seems to have changed over the past six months, so that many people now expect prices to fall. Consequently, an increasing number of homes are being put up for sale, while some potential buyers are hesitant since they believe that they may be able to buy at a lower price in e.g. six months' time. An equivalent, and even more pronounced, change of mood appears to have taken place in the market for summer cottages. In an interim period these shifts in expectations may have considerable consequences for the housing market and amplify the effects of changes in interest rates. In most of Denmark, housing prices have developed at a more measured pace and there is equivalently less concern about an adjustment.

The strong increase in cash prices over a number of years has primarily stimulated housing investments. The consumption ratio, i.e. consumption as a ratio of income, has also increased, cf. Box 4, but probably by less than expected beforehand, so that home equity has grown substantially – by an estimated kr. 560 billion in total for 2005 and 2006. This shows that in general households have only converted a small part of the capital gains achieved in recent years to consumption. This leaves them with a sound buffer against a slowdown in housing prices. For homeowners that purchased when prices peaked, a potential drop in prices would be a setback, but is hardly likely to threaten the economy or financial stability.

DO LARGE FLUCTUATIONS IN HOUSE PRICES CONSTITUTE A PROBLEM?	Box 4
After a prolonged downward trend, cash prices have been rising constantly since 1993, but a slowdown has set in during the last six months. Viewed over the last 25 years, the prices of owner-occupied homes have fluctuated considerably. The fluctuations in house prices and unemployment have been mirror reflections of each other, cf. Chart 6. This Box analyses the extent to which the large fluctuations in house prices constitute a problem both for the individual and for society at large. The conclusion is that large fluctuations do present problems, but can be difficult to avoid. A unique characteristic of the housing market is that the supply of homes is constant in the short term. Therefore price fluctuations on a given change in demand are particularly pronounced in this market compared with the market for consumer goods, where supply can be adjusted to match demand relatively easily. Large fluctuations in house prices are thus inherent, as in housing markets worldwide.
HOUSING PRICES AND UNEMPLOYMENT	Chart 6
Source: Statistics Denmark and the Association of Danish Mortgage Banks.
Fluctuations in house prices are a greater problem for the households than fluctuations in e.g. stock prices, since a home is not only an investment, but also a consumer good. Factors such as age, childbirth, divorce, death of a spouse and other social events, rather than actual investment strategies, often spur the decision to buy or sell a home. People can choose to stay out of the stock market, but not the housing market. Since the letting market in many cases functions poorly, resulting in long waiting lists, the purchase of a home may be the only option, even if the price is considered to be unattractive at the time of purchase. Large fluctuations in housing prices thus not only present problems in relation to the cyclical position and the stability of the economy, cf. below, but also with regard to the distribution of wealth across regions and generations, and between owners and tenants. Purchasing a home when prices were high or low can have a decisive impact on the private finances and wealth of the individual. For existing homeowners, rising house prices primarily imply a capital gain, which gives them an opportunity to increase consumption. The costs of entering the housing market for 1st time buyers can be calculated in several ways. Often, 1st-year payments after tax as a percentage of disposable income are used since this illustrates the fixed amount payable to service the loan, property tax, etc. on purchase of a fully-mortgaged home when all tax aspects are taken into consideration. The 1st-year payments after tax therefore also include repayments on the loans. Repayments are not a cost for living in the house in an economic sense, but rather a savings amount, i.e. home equity, built up as the debt is paid off. 1st-year payments after tax are affected by the current economic policy. 1st-year payments after tax as a ratio of disposable income have been increasing since 1993, as a result of rising housing prices, cf. Chart 7. However, the increase is far smaller than the increase in cash prices, since both the interest-rate level and the effective taxation of real estate have fallen in this period. Higher prices per square metre have thus to some extent been set off by lower loan costs and taxes. Especially in recent years, the increase in housing prices has, however, dominated, leading to a substantial increase in 1st-year payments. This nationwide average conceals considerable regional differences in 1st-year payments as a ratio of disposable income, in terms of both the level and the development over time.
1st-YEAR PAYMENTS AFTER TAX AS A RATIO OF DISPOSABLE INCOME	Chart 7
Note: "1st-year payments after tax" are calculated for an average home with a bond loan covering 80 per cent of the property value, while secondary financing is a mortgage loan at a rate of interest that is 2 per cent higher than the rate payable on the bond loan. In 2006 the average home value was kr. 1.6 million. Property tax has been taken into account. In the Chart, the 1st-year payments after tax are stated in relation to the disposable income of a homeowner. The disposable income is calculated on the basis of the most recent consumption survey (level) and distributed over time via an index of the development in disposable income for a wage earner in industry (own calculation). Source: Statistics Denmark and own calculations.
Changes in the framework for home financing have led to the introduction of new types of mortgage-credit loans over the last 10 years, i.e. variable-rate loans in 1996 and deferred-amortisation loans from the autumn of 2003. The latter is a natural addition to the product range, but this type of loan can present some problems for 1st time buyers. Some households have appeared to perceive the lower 1st-year payments after tax on deferred-amortisation loans as an actual cost reduction. An analysis of explanatory factors behind the increases in housing prices in recent years indicates that the introduction of deferred-amortisation loans has contributed to inflating housing prices, but there are also other explanations. To the extent that lower repayments have augmented housing prices, these loans have actually made it more difficult to get onto the owner-occupied housing ladder and have thus primarily benefited existing homeowners. Deferred-amortisation loans will often entail a smaller home-equity buffer in the event that the market reverses or major repairs to the property are required.
CONSUMPTION RATIO AND REAL INVESTMENTS	Chart 8
Note: The "consumption ratio" is private consumption as a ratio of the households’ disposable income, with the addition of net pension contributions. Partial estimates for 2006. Source: Statistics Denmark.
From an economic point of view, it is an advantage if house prices develop at a fairly steady rate, typically in step with the development in construction costs, since excessive fluctuations in house prices can be detrimental to the economy. Large price increases may exert inappropriate pressure on the economy, thereby leading to general inflation, while diving prices can lead to unemployment and low capacity utilisation, as in the late 1980s. House prices mainly influence the economy via construction activity and private consumption.   Residential investments, cf. Chart 8, follow the development in the real cash price closely and are among the most cyclically-sensitive demand components in the economy. If price increases are moderate, the construction sector usually has the capacity to ensure the required expansion and maintenance of the housing stock, but large increases in house prices may lead to bottlenecks. This exerts upward pressure on wages and the price of construction materials, with a risk of further inflation, as well as a shortage of construction materials. The rest of the economy is affected, for example because during an upswing labour is attracted to the construction sector from other, lower-paid sectors. In a recession, on the other hand, the construction sector may almost come to a standstill. This also applies to related sectors such as suppliers of home fittings and furnishings, kitchens, domestic appliances, etc. House prices are procyclical. When house prices rise during an upswing, housing wealth increases. Homeowners can convert this price increase into consumption, either by selling the home or by mortgaging the home equity, thereby stimulating the economy further. The result will be an increase in the consumption ratio since capital gains on real estate allow higher consumption for a given income. This link was evident in the 1980s and early 1990s, while the rising house prices since 1993 have only led to a minor increase in the consumption ratio, cf. Chart 8. Taxation rules and the framework for home financing have had a significant impact on the development in housing prices. In the 1980s a large reduction of the tax value of the mortgage interest deduction, combined with the " mixed loan" requirement, contributed strongly to the fall in real housing prices from 1986 to 1993. On the other hand, the tax freeze and the introduction of deferred-amortisation loans have contributed to upward pressure on housing prices in recent years.

Labour market, wages and prices
The labour market has tightened further since the summer. Unemployment fell at a surprisingly strong rate in the 2nd half of 2006, reaching seasonally adjusted unemployment of 107,300, equivalent to 3.9 per cent of the labour force, in December. This is a decline by approximately 15,000 in six months. In addition, the number of people on activation schemes, adjusted for seasonal fluctuations, fell by almost 6,000 in the same period. According to the regional labour market councils, the shortage of labour intensified in all sectors in 2006, particularly in the cyclically sensitive building and construction sector. The number of vacancies, measured as the number of jobs advertised, is also very high, cf. Chart 9, so there is no imminent indication that the labour market is cooling down.

Unemployment declined because employment grew more than the labour force expanded. The larger labour force reflects a rising participation rate. Commuting from especially Sweden and Germany is on the increase, and these commuters are included in the labour-force statistics in the national accounts. Net payroll costs to abroad display a clear rising trend as unemployment in Denmark declines, cf. Chart 10.

The current shortage of labour is primarily of a cyclical nature, but all other things being equal, the demographic changes whereby the age groups from which the labour force is predominantly recruited are becoming relatively smaller, will accentuate the problem in the future. The recruitment problem will be particularly pronounced in the public sector in the coming years, cf. Box 5.

AGE DISTRIBUTION OF THE LABOUR FORCE BY SECTOR	Box 5
The age groups with the highest participation rates will account for a diminishing ratio of the total population in the coming years as the demographic structure changes. The exit from the labour force is likely to be particularly pronounced in the public sector, where the average age of employees is higher than in the private sector, cf. Chart 11. Especially the education sector has a relatively high number of public-sector employees who are approaching retirement age.
DISTRIBUTION OF EMPLOYEES BY AGE GROUP	Chart 11
Source: Statistics Denmark and own calculations.
The number retiring from employment in the next five years can be estimated at 300,000, of whom public-sector employees constitute 113,000, equivalent to 38 per cent, provided that the retirement patterns are the same in the public and private sectors. Today, public-sector employees constitute 30 per cent of those in employment, and are thus overrepresented in the age groups on the verge of retirement. The outflow means that one in seven public-sector employees can retire within the next five years, and one in four within the next 10 years. The participation rate among the 60-64-year-olds has been rising, but is still below the level in countries such as Sweden and Norway. The ageing of the population increases the demand for labour-intensive core public services such as healthcare and care for the elderly, so that competition for labour between the public and private sectors can be expected to intensify in the future.

Inflation measured by HICP declined in the autumn and stood at 1.8 per cent in January 2007, compared to 2.0 per cent in January 2006. The lower rate of price increase is primarily a result of the falling energy prices in the autumn, so that the price of oil at the beginning of 2007 was at the same level as one year earlier.

Even though inflation is moderate, the underlying pressure on prices seems to be increasing. The high level of activity in the building sector has thus exerted strong upward pressure on building materials prices, which were 5.7 per cent higher in the 3rd quarter of 2006 than one year before. This is the highest rate of increase in 16 years.

The tighter labour market and greater capacity utilisation have led to mounting domestic price pressure since the beginning of 2005, with a rising trend for domestic market-determined inflation (IMI). The underlying factors include a higher rate of wage increase, at 3.2 per cent in the 4th quarter, according to figures from the Confederation of Danish Employers. This means that Danish wages are still rising at a faster rate than among Denmark's competitors. In addition, a lower rate of increase in prices of imported energy may be reflected in rising profit margins, since the latter have for some time been squeezed by high energy and import prices.