Recent Economic and Monetary Trends

This review covers the period from mid-September to early December 2008

SUMMARY

The international financial crisis that began in the summer of 2007 in tensified further in the autumn of 2008. The crisis escalated after the US authorities had allowed the investment bank Lehman Brothers to fail in mid-September. Stock prices fell, the money markets ceased to work properly and several smaller currencies came under pressure. Defaults, mergers and nationalisation characterised the financial sector, and in many countries, including Denmark, governments launched extensive rescue packages to mitigate the crisis. The free fall of the financial sys tem was stopped.

The financial crisis has had real economic repercussions, and the global economic prospects have become gloomy. Housing prices are falling in many countries. This, combined with lower stock prices, tighter credit conditions, rising unemployment and a weaker economic outlook, has lead to more restraint on the part of business enterprises and con sumers. On the other hand, oil prices and global inflationary pressures have receded in recent months, thereby increasing real incomes. More over, many central banks have eased their monetary policies consider ably. The general perception is that economic activity in the industrial ised world will decline until the end of 2009 and then slowly pick up again.

The financial crisis has also hit Denmark. The Danish krone came under pressure in September and October, and in order to support it Danmarks Nationalbank purchased kroner against foreign exchange for a consider able amount. When this proved to be insufficient, Danmarks National bank, in accordance with the fixed-exchange-rate policy, raised its policy interest rates.

Economic growth in Denmark has been falling since 2006, following some years of strong expansion. The slowdown, which was originally caused by a capacity squeeze, has been exacerbated by the financial cri sis and the weaker international economy. Growth has declined more rapidly than expected, but production resources are still under pressure. Unemployment is very low, wage increases are high, and inflation is ap preciably above the euro area level.

The economy is slowing down in Denmark, but from a more favourable starting point than in the rest of the world. Disposable real incomes will grow substantially in 2009 on account of rising real wages and tax cuts. In addition, the taxation and transfer system will automatically moder ate the cyclical reversal. Disbursements of unemployment benefits will increase, and tax revenue will fall. The current situation with high wage increases and indications of rising, but still low, unemployment leaves no scope to go further in terms of economic policy. An economic policy aimed at maintaining employment above the level that is compatible with wage and price stability is unsustainable.

THE INTERNATIONAL ECONOMY

The international financial crisis escalated in the autumn of 2008. Particularly after the default of the investment bank Lehman Brothers in mid-September, the international money markets froze and investors' risk appetite waned considerably. In this phase of the crisis, emerging market economies were also severely affected. The development of the financial turmoil in the autumn of 2008 is elaborated on in The Inter national Financial Crisis on p. 25.

Stock prices worldwide plummeted from the summer of 2008 until the end of October, notably in the emerging market economies, cf. Chart 1. In a historical context, the stock market dive in September and October was among the steepest ever seen. During the 40 trading days from 1 September until 27 October, the US S&P 500 index dropped by 33 per cent, corresponding to the fall in October 1987. The all-time record over 40 days was, however, set in October and November 1929, when the S&P 500 index tumbled by more than 40 per cent. Since late October prices have remained at a lower level with considerable day-to-day fluctu ations. The VIX index¹, which is based on the 500 largest US stocks, rose above 80 in October. Since 1990 it has fluctuated around 20, and it has never previously exceeded 50. A high value of the VIX index indicates great uncertainty concerning future price developments and thus high risk for investors.

The strongest day-to-day fluctuations since the millennium rollover have been observed for several exchange rates. In addition, the relative values of the major currencies have shifted considerably. The dollar has strengthened against the euro, and the yen has strengthened even more, cf. Chart 2. The Swiss franc also appreciated substantially vis-à-vis the euro during September and October, but fell back somewhat in November. The strengthening of the yen and the Swiss franc is to some extent attributable to settlement of "carry trades", whereby investors borrow in low-interest countries such as Japan and Switzerland and invest in high-interest countries. The pound sterling weakened by 5 per cent against the euro from the end of September to the end of Novem ber in step with the relatively strong downturn in the UK economy and substantial rate cuts.

Capital outflows in the wake of the financial crisis put several small er currencies under pressure in the autumn. The Norwegian krone and the Swedish krona weakened by 11 and 8 per cent, respectively, against the euro from early September to the end of November. In Iceland, cf. Box 1, and several emerging market economies, including Ukraine, Hungary and Pakistan, capital outflows have necessitated the establishment of large-scale IMF loan programmes in order to stabilise the economies. The rescue packages are aimed at restoring access to the international capital markets and supporting sustainable economic development.

International real economy
The global economy has weakened substantially as a result of the financial crisis, and growth estimates for 2009 have been adjusted con siderably downwards, cf. Chart 3. It is quite common for preceding fi nancial turmoil to reinforce an economic downturn.²

The economic slowdown has been particularly pronounced in the industrialised countries. In the 3rd quarter of 2008, GDP fell in both the USA and the euro area, and indicators point to a further decline in the 4th quarter. Investments and private consumption have weakened con siderably, and recently the financial crisis and growing pessimism among consumers and in the corporate sector have reinforced this downward trend. Since the summer of 2007, consumer confidence in the major industrialised countries has dropped to a very low level compared with previous years, cf. Chart 4. Particularly consumption of consumer dur ables has been affected, and US car sales are at their lowest level since the 1980s. Business confidence indicators have also fallen worldwide, and the propensity to invest is weak.

Tighter credit conditions have led to further loss of confidence. Since mid-2007 US and euro area banks have tightened their lending condi tions for all types of loans to the corporate sector and the households, cf. Chart 5. Concerns about the credit risk on borrowers, and restricted borrowing possibilities for the banks themselves, have been cited as the underlying factors. At the same time, it has become extremely difficult for business enterprises to issue corporate bonds, and the yield spread to government bonds has become very wide. For the households, falling housing prices and rising unemployment limit the access to credit.

Unemployment in the USA has been increasing since mid-2007. The trend accelerated during 2008, with unemployment in October reaching the highest level since the early 1990s. Euro area unemployment has risen only modestly since it bottomed out in March 2008. As investments and private consumption continue to decrease and confidence indicators remain weak, unemployment is expected to continue to rise in most industrialised countries in the near future.

In the emerging market economies, dynamics are moderated by less favourable sales opportunities in the global market, as well as weaker domestic demand. Commodity exporters, in particular, are severely af fected, but also China and India have seen growth fall to the lowest level in several years.

According to the IMF's latest estimate overall global growth will de cline from 5.0 per cent in 2007 to 3.7 per cent this year and 2.2 per cent in 2009. Both the IMF and the OECD³ expect aggregate output in the industrialised countries to fall for the first time since World War II. A turnaround is not expected until the 2nd half of 2009 at the earliest, and it will take some time for growth to return to normal levels. For the emerging market economies and developing countries taken as one, the IMF expects a growth rate of 5 per cent 2009. This is considerably lower than in recent years, but higher than in previous recessions. According to the estimates from the international organisations, global economic growth in 2009 will thus be driven solely by emerging market economies and developing countries.

International price developments
The inflationary pressures affecting most economies since mid-2007 are easing. These pressures were mainly attributable to rapidly rising com modity prices for agricultural commodities, metals and energy, a trend that has reversed strongly in recent months, cf. Chart 6. By end-Novem ber a barrel of Brent crude oil had fallen to around 50 dollars from a peak of 143 dollars at the beginning of July. The contraction of the economy has reduced demand, and in addition the supply of oil from OPEC countries has increased compared with 2007. Sea freight rates have also gone down, reflecting lower global demand and greater freight capacity.

The OECD expects consumer price inflation in the OECD countries to fall from 3.3 per cent in 2008 to 1.7 per cent in 2009, and concerns about second-round effects of the elevated inflation level since the summer of 2007 have lessened. The lower rate of inflation helps to boost real in come, thereby stimulating consumption and investments. In several emerging market economies inflation is more persistent, and the IMF only expects it to fall from 9.2 per cent in 2008 to 7.1 per cent in 2009.

Economic policies
Many countries have implemented rapid series of economic policy ad justments to halt the spiral of economic slowdown and weakening of the financial system. A safety net has been put in place under the finan cial system – with liquidity, government guarantees and capital injec tions, cf. The International Financial Crisis on p. 25.

The alleviation of inflationary pressures has provided scope to ease monetary policy. On 8 October 2008, the European Central Bank (ECB), the Federal Reserve, the Bank of England, Sveriges Riksbank, the Bank of Canada and the Swiss National Bank cut their key policy rates by 0.5 per cent in the first coordinated action ever. Later in the autumn, the Federal Reserve and the ECB further reduced their rates by 0.5 per cent to 1 and 3.25 per cent, respectively. On 4 December, the ECB cut its rate by another 0.75 per cent. In mid-November the Swiss National Bank reduced its interest rate by 1 percentage point, while the Bank of England opted for a cut by as much as 1.5 per cent at the beginning of November 2008 and by a further 1 percentage point, to 2 per cent, on 4 December; this is the lowest level since the 1950s. Sveriges Riksbank re duced its interest rate on two occasions in October, by a total of 1 per centage point to 3.75 per cent, and by a further 1.75 per cent on 4 December, thus landing at 2 per cent. Tighter lending conditions mean that the central-bank rate cuts have not been fully passed through to consumers and business enterprises by way of lower interest rates.

Fiscal policy has also come into focus, and a number of international organisations have called for easing of fiscal policy to counteract the re cession. In mid-November, IMF Managing Director Dominique Strauss-Kahn stated that in the current situation the IMF advocates a strong, coordinated fiscal expansion at the global level. Taking into account the economic situation of the individual countries, the recommended target is a fiscal stimulus of 2 per cent of world GDP.

In late November, the European Commission published a communica tion on a European Economic Recovery Plan. The Plan proposes an im mediate budgetary impulse of 1.5 per cent of GDP, of which 1.2 per cent is to be made up of a budgetary expansion by member states within the framework of the revised Stability and Growth Pact, while the remain der is to come from increased EU funding. The proposals in the Plan were on the agenda for the summit of the EU heads of state and gov ernment on 11-12 December 2008.

In its Economic Outlook from the end of November 2008, the OECD states that in the current unusual situation, fiscal policy stimulus has an important role to play, but stresses that the room for budgetary man oeuvre varies considerably among OECD countries. The OECD emphas ises that it is important to ensure long-run public finance sustainability, and that uncontrolled accumulation of debt could trigger unfavourable reactions in the financial markets.

THE DANISH ECONOMY: MONETARY AND EXCHANGE-RATE CONDITIONS

The Danish krone weakened in September and October as the inter national financial crisis intensified. The pressure on the krone followed a period in which the spread between Danmarks Nationalbank's lending rate and the ECB's marginal rate had been negative, cf. Chart 7. In September, the ECB's marginal rate rose to a level considerably above the minimum bid rate, because euro area banks had been requesting more liquidity from the ECB in the weekly tenders. The negative interest-rate spread between Denmark and the euro area was also reflected in a negative implied yield spread for FX swaps between kroner and euro.

To stabilise the krone, Danmarks Nationalbank intervened in the for eign-exchange market, buying kroner against foreign exchange for a considerable amount from late September to early October. However, this proved insufficient to withstand the pressure on the krone, and in accordance with the fixed-exchange-rate policy Danmarks Nationalbank unilaterally raised its policy interest rates. On 7 October, Danmarks Nationalbank announced that the lending rate and the rate of interest on certificates of deposit would be raised by 0.4 per cent to 5 per cent effective from 8 October. The discount rate and the current-account rate were raised by 0.25 per cent to 4.5 per cent.

Danmarks Nationalbank subsequently continued to intervene in the foreign-exchange market to stabilise the krone. On 8 October around midday, the ECB announced a reduction of the minimum bid rate by 0.5 per cent to 3.75 per cent. Later on the same day, the ECB announced that, until further notice, the weekly main refinancing operations would be carried out at a fixed rate, corresponding to the minimum bid rate, whereas they had previously been variable-rate tenders. This change of instrument meant that the actual policy interest-rate spread between Denmark and the euro area widened to 1.25 per cent since Danmarks Nationalbank kept its policy interest rates unchanged.

At the end of October, Danmarks Nationalbank intervened again, pur chasing kroner against foreign exchange to stabilise the krone, which was still under pressure due to a continued outflow of foreign ex change. This to some extent reflects how the mounting financial crisis caused investors to withdraw from minor currencies, including the Dan ish krone. On 24 October, Danmarks Nationalbank raised the lending rate and the rate of interest on certificates of deposit by a further 0.5 per cent to 5.5 per cent in response to the sustained pressure against the krone. This meant that the spread between Danmarks Nationalbank's lending rate and the ECB's minimum bid rate widened to 1.75 per cent.

From the end of October the krone strengthened and Danmarks Nationalbank was able to repurchase foreign exchange. On 6 November, Danmarks Nationalbank, mirroring the ECB, cut its policy interest rates by 0.5 per cent, so that the lending rate and the rate of interest on cer tificates of deposit landed at 5 per cent and the discount rate and the current-account rate at 4 per cent, effective from 7 November.

Like the ECB, Danmarks Nationalbank cut its policy interest rates on 4 December. The lending rate and rate of interest on certificates of de posit were reduced by 0.75 per cent to 4.25 per cent and the discount rate and the current-account rate by 0.5 per cent to 3.5 per cent, effective from 5 December. The spread between Danmarks National bank's lending rate and the ECB's minimum bid rate thus remained at 1.75 per cent.

The money market
In September and October the markets became much more nervous. The lack of confidence between banks became more pronounced, banks be came less willing to grant uncollateralised loans in the money markets, and the spread between uncollateralised and collateralised money-mar ket interest rates widened considerably. To restore confidence in the fi nancial markets, western governments began to announce bank rescue packages towards the end of September. Nevertheless, the spread be tween uncollateralised and collateralised interest rates has remained wide in the euro area. This is also the case in Denmark, cf. Chart 8, which is a reflection of the fixed-exchange-rate policy vis-à-vis the euro.

In September, the banks had considerably larger current-account de posits than usual. The turbulent money markets, combined with heavy demand for liquidity around the end of the quarter, led to temporary suspension at the end of September of the current-account limit, i.e. the upper limit for the total current-account deposits of banks and mort gage-credit institutes at Danmarks Nationalbank.

The volume of trading in certificates of deposit among banks and mortgage-credit institutes was higher in September than in the previous months, cf. Chart 9. The total current-account deposit was high, but it was unevenly distributed, and the financial institutions therefore used certificates of deposit to smooth differences within the sector.

To boost liquidity, Danmarks Nationalbank, in line with other central banks, launched a series of temporary facilities in September and October. Furthermore, the Danish bank rescue package from early October 2008 helped to facilitate access to liquidity for banks. These measures are de scribed in more detail in The International Financial Crisis on p. 25.

Recent months have also seen a considerable lack of short-term dollar and euro liquidity among banks and mortgage-credit institutes in Den mark. In September and October, Danmarks Nationalbank contributed to alleviating conditions in the forward markets by selling foreign ex change from its reserve against kroner by way of FX swaps. In addition, Danmarks Nationalbank has established swap lines with the Federal Reserve and the ECB with a view to offering dollar and euro loans to Danmarks Nationalbank's monetary-policy counterparties. Five dollar auctions and one euro auction have been held.⁴

The net position of the banks and mortgage-credit institutes vis-à-vis Danmarks Nationalbank was reduced by kr. 69 million in October, cf. Table 1. This is primarily attributable to Danmarks Nationalbank's net sale of foreign exchange against kroner in connection with intervention for kr. 64 billion in October. When it becomes necessary to support the krone, Danmarks Nationalbank purchases kroner from a bank against payment in foreign exchange. This transaction reduces the foreign-ex change reserve and the net position. During September and October the banks and mortgage-credit institutes reduced their monetary-policy loans from Danmarks Nationalbank, which was reflected in lower hold ings of certificates of deposit. Over the same period, the financial insti tutions raised loans in foreign currency for kr. 85 billion from Danmarks Nationalbank under the swap lines established, cf. above. The net pos ition was reduced further in November due to factors such as the issuance of 30-year government bonds. The lower net position was re flected in an increase in monetary-policy loans.

Yields on mortgage-credit bonds and government bonds
The Danish mortgage-credit market was also affected by the escalation of the financial crisis. Yields on both long-term and short-term mort gage-credit bonds increased considerably in September and October, cf. Chart 10. At the same time, the spread to government yields widened considerably, cf. The International Financial Crisis on p. 25.

Against the backdrop of the unusual market conditions an agreement concerning financial stability in the pension area in Denmark was con cluded on 31 October 2008 between the Danish Insurance Association and the Ministry of Economic and Business Affairs. Moreover, the Danish government announced the opening of a 30-year Danish government bond in November. The aim was to improve the risk-hedging opportun ities available to the Danish pension sector.

At the beginning of November it was announced that the Social Pen sion Fund (SPF) would invest around kr. 22 billion in short-term mort gage-credit bonds in the December auctions with a view to covering the central-government interest-rate risk related to the financing of sub sidised housing.

The yield on a 10-year government bond was approximately 3.9 per cent at the end of November, slightly lower than at the end of Septem ber. The yield spread to an equivalent German bond widened from around 0.3 per cent at the end of September to 0.6 per cent at the end of November. Other European countries also experienced a considerable widening of the yield spread to German government bonds.

Bank interest rates and credit
The banks raised their interest rates on several occasions in October, citing higher financing costs, including Danmarks Nationalbank's higher interest rates. From the onset of the turmoil in the summer of 2007 until October 2008, the banks' average interest rates on lending to house holds and the corporate sector rose by 0.8 and 1.0 per cent, respectively, while the corresponding deposit rates rose by 0.5 and 0.8 per cent, cf. Chart 11. In November, several banks announced that interest rates would be lowered by 0.5 per cent following Danmarks Nationalbank's interest-rate cut.

Total growth in lending by banks and mortgage-credit institutes has been declining since the beginning of 2007, but remained at a relatively high level at end-October, cf. Chart 12. Especially lending to households has dampened, reflecting the more moderate growth in private con sumption and housing investments.

The economic slowdown and falling housing prices reduce the demand for loans from banks and mortgage-credit institutes. The lending oppor tunities of the latter are closely linked to the value of real property. Falling cash prices and fewer new construction projects will dampen lending by mortgage-credit institutes in the coming years, but homeowners still have considerable home equity that could potentially be mortgaged.

Besides affecting demand and reducing the collateral base, an economic slowdown can lead to tightening of credit conditions by loan providers to an extent where even creditworthy applicants are rejected.

With the Danish rescue package from October, all unsecured creditors are certain to get their money back in a timely manner. This has created a good foundation for the banks again to obtain financing in the na tional and international financial markets.

Nevertheless, the banks are faced with major challenges, and there is a risk that the current liquidity crisis could turn into a genuine credit crisis, resulting in an unnecessary setback for the Danish economy.

The development in the international financial markets has made it extremely difficult for Danish banks to obtain new capital in the markets at a time when they are expected to be in need of extra capital.

At end-2007, the Danish banking sector held excess capital in relation to the statutory solvency requirement totalling almost kr. 90 billion. Losses of 1 per cent of loans and guarantees will amount to kr. 27 bil lion. The excess capital would thus cover accumulated losses of just over 3 per cent. During the deep slump in the late 1980s and early 1990s, accumulated losses in the period 1991-94 were just over 7 per cent of loans and guarantees. Earnings were unable to offset losses of this magnitude, and accumulated accounting losses – and thus undermining of equity – reached a level corresponding to 1.4 per cent of loans and guarantees. In practice, banks will not reduce their excess capital to zero, and some banks may experience difficulties in obtaining new cap ital long before the excess capital has reached zero. In addition, around kr. 20 billion of the banks' subordinated loan capital matures in 2009 and 2010.

It is an international phenomenon that banks are finding it difficult to attract capital in the markets. Many countries have therefore opted for government capital injections in connection with bank rescue packages. In the EU, a total of 280 billion euro has been injected into the banking system. The effect has been that the implied international market stand ard for the core capital coverage of international banks has risen to 11 per cent. This has put the Danish banks under pressure to increase their capital adequacy to meet the new international market standard. Unless capital is injected into the banks, this can only be achieved by reducing the balance sheet.

Denmark may thus end up in a situation in which even creditworthy borrowers are refused bank loans. To reduce the risk of such a credit crunch, which could reinforce the economic slowdown, it is necessary to ensure that well-run Danish banks gain access to temporary financing on conditions that resemble those in the market as closely as possible so that the banks can continue to act as intermediaries between savers and creditworthy borrowers.

THE DANISH ECONOMY: REAL ECONOMY

Economic growth in Denmark has been declining since 2006, following some years of high growth. The slowdown, which was originally caused by a capacity squeeze, has been exacerbated by the financial crisis and the weaker international economy. According to the most recent nation al accounts, GDP fell by 0.5 per cent in the 3rd quarter of 2008, adjusted for seasonal fluctuations and price developments. Compared with the same quarter of 2007, GDP was down by 1.2 per cent.

Although growth in demand has moderated, the output level remains high and considerably above the level that is estimated to be compatible with wage and price stability. Unemployment is still very low, household finances are generally sound and the balance of payments and public finances show surpluses. Compared with other countries, Denmark is thus in a strong position to tackle the challenges posed by the financial crisis and the global economic slowdown.

The crisis has affected the business enterprises' expectations of future employment and revenue, and in November confidence indicators were close to the level seen during the recession in the early 1990s, cf. Chart 13. The weaker prospects have also been reflected in corporate investments, which have been stagnant in the last year, but remain high. Consumers, too, have felt the financial crisis and the pessimistic sentiment in the public debate, and in the autumn of 2008 consumer confidence fell to the lowest level for 18 years. Lower retail and car sales over the last year also point to restraint, cf. Chart 14.

Total real private consumption, which includes e.g. services, housing costs and tourism, rose by 1.6 per cent in the first three quarters of 2008 compared with the same period of 2007. The increase is attributable to factors such as increased consumption of services. Growth in consump tion has thus moderated in relation to the period 2004-06, but never theless persists. The slower growth in private consumption is to some extent a result of higher interest rates, as well as lower household wealth due to falling equity and house prices.

Although home equity has decreased, the average level remains high, at around kr. 800,000 per home in the 3rd quarter of 2008. Moreover, real disposable incomes are expected to increase by approximately 3 per cent in 2009 – on average around kr. 11,000 per household – due to relatively high wage increases and lower income taxes. Overall the finances of the households are thus sound.

The housing market
The rising interest rates until the autumn of 2008 have contributed to a slowdown in the housing market. According to the Association of Danish Mortgage Banks, average sales prices for single-family and ter raced houses have fallen by just over 5 per cent since they peaked in the 2nd quarter of 2007. The market for owner-occupied flats has also run out of steam, with average sales prices down by 16 per cent since the reversal in the 3rd quarter of 2006. The lower prices have contributed to a small decline in housing investments from the high level at the end of 2006.

While sales prices for single-family and terraced houses peaked in the spring of 2007, average asking prices continued to rise until January 2008. They have subsequently declined, but not as rapidly as sales prices, meaning that the gap has widened. This undoubtedly reflects reluctance on the part of sellers to accept prices that are significantly lower than anticipated. As a consequence, turnover in the housing market has fallen, cf. Chart 15, while the number of houses for sale has risen sharp ly. This means that houses are staying on the market for longer.

Expectations of falling prices in the near future, the sellers' reluctance to lower their asking prices and the slower economic growth all contrib ute to weakening the housing market, and further falls can be expected in the short term.

Foreign trade and balance of payments
In spite of the international slowdown, exports of Danish goods and services rose by 3.8 per cent in the first nine months of 2008 compared with the same period of 2007. The seasonally adjusted monthly trade surplus (excluding ships) increased to around kr. 4 billion in the summer of 2008, after having displayed a steady downward trend in the preceding years. In recent months, exports of goods have stagnated, while imports have continued to grow. The trade surplus has thus been reduced somewhat.

The reasons for the decrease in exports of goods are that the value of energy exports has fallen in step with oil prices since the summer and that industrial exports have slowed down since May. The latter has also resulted in a more pessimistic industry assessment of orders from export markets since the spring. In view of the gloomy outlook for the Danish export markets, export growth is expected to subside further in the near future.

The current-account surplus has been growing steadily since the end of 2007. In September, the accumulated 12-month surplus was kr. 33 bil lion, which is almost kr. 22 billion higher than in the same period one year earlier. The improvement reflects that the surplus on trade in ser vices has remained high, while the last few years' rapid deterioration of the surplus on trade in goods has been halted. In addition, the invest ment income surplus increased substantially in 2008. Investment income is primarily driven by income from outward foreign direct investment; data for the current year are projections based on corporate profit ratios in previous years. In other words, investment income in 2008 is subject to considerable uncertainty and will be revised when the annual accounts for 2008, and thus the surplus on direct investment for this year, are incorporated into the statement.

Labour market, wages and prices
The economic slowdown is gradually affecting the labour market. Unemployment rose a little from September to October 2008, having displayed a downward trend for almost five years. Moreover, the shortage of labour in the industrial and construction sectors has eased considerably since 2007, and the number of new jobs posted on the Internet has been declining since the turn of the year.

Although the demand for labour has fallen, the labour market re mains tight. Seasonally adjusted employment was still very high in the 3rd quarter of 2008, and seasonally adjusted unemployment was 47,700, i.e. 1.7 per cent of the labour force, in October. This is substantially below the level estimated to be compatible with wage and price stabil ity. In the autumn of 2008 the number of job vacancies posted on the Internet every month matched the level at the end of 2005, when un employment was falling. In addition, the shortage of qualified labour is still pronounced in the less cyclically sensitive sectors, including the public sector.

Pressures on the labour market have also been reflected in higher wage increases in recent years. In the private sector, wages rose by 4.5 per cent in the 3rd quarter of 2008 compared with the previous year. The rate of wage increase declined slightly from the 2nd to the 3rd quarters of 2008, but remained high compared with previous years. Wage pressures are still pronounced in the construction sector, although activity has declined and the shortage of labour has become less pronounced. In the public sector, the rate of wage increase has risen in 2008 to date, a trend that will continue for the rest of the year as the wage adjustments agreed during the collective bargaining in the spring are implemented.

For some years, wage increases in industry have exceeded those abroad, so that wage competitiveness has deteriorated and Denmark has lost market shares. Competitive pressures intensified because the krone strengthened vis-à-vis the currencies of Denmark's trading part ners until the summer of 2008. In August, the effective krone rate was at the highest level seen since the mid-1970s. Subsequently, it has weak ened a little, but remains higher than in previous years.

The strong wage developments, coupled with higher food and energy prices, have contributed to a rapid rise in consumer prices over the past year. In October 2008, consumer prices, measured by HICP, were 3.8 per cent higher than in the same month of 2007. Annual consumer price in flation has receded since August, reflecting falling energy and food prices. As the energy and food price hikes seen in the autumn of 2007 gradually drop out of the calculations, this will also have a downward impact on the annual rate of price increase.

In spite of the fall, consumer price inflation remained higher in Den mark than in the euro area in October, even when energy, food alcohol and tobacco prices are excluded, cf. Chart 16. The higher wage and price pressures in Denmark reflect a greater capacity squeeze than in the euro area.

Economic outlook
In the near term, demand in Denmark's export markets is expected to weaken further due to the global slowdown. At the same time, growth in private consumption and investments will moderate as stock prices have dived, housing prices are falling and banks are applying more restrictive credit policies. Lower growth, both at home and abroad, also makes consumers and business enterprises more cautious. On the other hand, demand is boosted by lower oil prices and the slightly weaker effective krone rate. Tax cuts, robust household finances and the sustained low level of unemployment are also expected to buoy up consumption.

Available evidence points to a stagnation in Danish output in 2008, a trend that is set to continue into 2009. The slowdown has thus material ised faster than predicted by Danmarks Nationalbank in September. Un employment will rise in the coming years on account of the weaker economy, but is nonetheless expected to remain below the structural level until 2010. Pressures on the labour market are intensified by demo graphic trends that will reduce the supply of labour as the age groups with the highest participation rates decline. This will have a negative im pact on growth opportunities and fiscal sustainability in the long term. In other words, it will still be necessary to implement measures to in crease the supply of labour and promote adaptability, cf. Development in the Labour Supply on p. 85.

Denmark's starting point, with extensive pressures on the labour mar ket, differs from that of most other countries. Consequently, wage increases in Denmark can also be expected to exceed those abroad in the next few years, thereby further weakening wage competitiveness. To limit the loss of market shares and avoid an unnecessarily high and prolonged rise in unemployment, wage and price pressures must be dampened. The alleviation of labour market pressures will help to achieve this.

Public finances automatically stabilise the Danish economy. During a slowdown, higher unemployment will increase expenditure for benefits, and the tax and revenue base will shrink. These "automatic stabilisers" will moderate the cyclical reversal, as will sound real-wage increases and tax cuts in 2009. The current situation, with wage pressures remaining high, leaves no scope to go further in terms of economic policy than to let the automatic stabilisers work.