Report of the Board
of Governors

Summary

The third stage of Economic and Monetary Union, EMU, commenced on 1 January 1999 with the introduction of the euro in 11 EU member states. At the same time the European Central Bank, ECB, took over the responsibility for monetary policy in the 11 participating countries. Denmark does not participate in EMU and Danmarks Nationalbank continues to be responsible for monetary policy in Denmark.

The introduction of the euro does not imply any real change in Denmark's foreign-exchange policy. Denmark will continue to pursue the fixed-exchange-rate policy which has been a cornerstone of Danish economic policy since the beginning of the 1980s. The foreign- exchange-policy objective is now to maintain a stable krone rate against the euro.

As a natural continuation of the fixed-exchange-rate policy, in September 1998 Denmark concluded an agreement with the euro area member states and the European Central Bank on participation in the new exchange-rate mechanism, ERM II, which entered into force on 1 January 1999. Denmark participates in ERM II with a central rate against the euro of kr. 746.038 per 100 euro and a fluctuation band of +/- 2.25 per cent. The fluctuation band serves as a safety net, since in practice the Nationalbank stabilises the krone within a narrower band.

As a result of this policy the krone fluctuated little against the D-mark in 1998. The Nationalbank sold foreign exchange in periods when the krone was subject to pressure and purchased foreign exchange in other periods. The net result of the intervention in the foreign-exchange market was a reduction of the foreign-exchange reserve by kr. 29 billion.

The Nationalbank raised its official interest rates when the krone came under pressure in May and September. In the final months of 1998 and in the beginning of 1999 the interest rates were lowered on several occasions in step with the Nationalbank's purchases of foreign exchange. In addition the Nationalbank lowered the interest rates in December 1998 after a coordinated lowering of interest rates in the 11 euro area member states. The differential between short-term Danish and German interest rates was around 0.5 per cent in February 1999.

In 1998 the international capital markets were affected by the unrest which began in Southeast Asia in 1997 and intensified when Russia in August 1998 suspended payments on its debt and ceased to peg the rouble to the dollar. This entailed considerable demand for safe and liquid government bonds issued by the major industrialised countries, leading to a significant drop in long-term interest rates. During the year long-term yields in the USA and Germany fell by 1.1 per cent and 1.4 per cent respectively. The yield differential vis-à-vis Germany of the previous high-interest countries Spain, Portugal and Italy narrowed in 1998 as the introduction of the euro drew closer. In February 1999 Denmark's yield differential to Germany was 0.4 per cent.

Growth in the gross domestic product, GDP, of Denmark's trading- partner countries is estimated at 2.6 per cent in 1998. The effects of the economic crises in Russia and Southeast Asia on the economies of the USA and the euro area in 1998 were only moderate.

The economic upswing which has characterised the Danish economy since 1993 continued in 1998. Preliminary statistics indicate GDP growth of 2.8 per cent in 1998. Unemployment has fallen and inflation is still low, but the balance problems in the economy are now more serious than before.

In 1998 the current account of the balance of payments showed a deficit for the first time since 1989. The marked deterioration in the balance of payments is due primarily to the strong drop in the trade surplus. Market shares on both domestic and export markets were eroded in the face of strong growth in costs and high capacity utilisation. Agricultural exports in 1998 were affected by low prices, and the labour-market dispute in the spring of 1998 also reduced exports.

Interest payments on Denmark's large external debt are substantial, making Denmark exposed in the event of unrest on capital markets. To ensure future scope for manoeuvre in economic policy it is crucial that the external debt be eliminated within a reasonable period.

In 1998 wages increased by 4.4 per cent, against 4.0 per cent in 1997. Denmark's wage increases were thus considerably higher than in the euro area. If Denmark is to retain its competitiveness vis-à-vis the euro area the scope for wage increases in coming years is limited. Unemployment continued to fall in 1998, reaching 6 per cent at the close of the year. This is the lowest level since 1980. Unemployment in Denmark is considerably lower than in the euro area.

Industrial and consumer-confidence indicators for the end of 1998 and the first months of 1999 show signs of a dampening of the Danish economy. As a consequence of the crises in Russia and Southeast Asia growth in our trading-partner countries is expected to decline. In order to achieve a sound current-account surplus domestic demand in Denmark must for a period show lower growth than abroad, irrespective of any weakening in activity abroad.

The objective of Denmark's monetary policy is to stabilise the krone, while it is up to fiscal policy to stabilise wages and prices. Since 1995 the monetary factors have had a clearly expansive effect on the domestic economy. This increases the demands of a tight fiscal-policy stance. The planned tightening of fiscal policy for 1998 does not appear to have been realised. The trend of recent years for fiscal-policy tightenings to be less effective than set out in the Finance Act thus continues. This makes it all the more imperative that the adopted fiscal tightening in 1999 is achieved and is maintained in 2000.

In 1998 government finances showed a surplus for the 2nd consecutive year. Government finances are estimated to have improved from a surplus of kr. 1 billion in 1997 to a surplus of kr. 11 billion in 1998. This reflects the automatic effects of the cyclical upswing, which should be utilised to ensure further consolidation.

The banks' total profit for the year rose to kr. 14 billion. Losses and provisions on debtors increased moderately. Estimates show that for the 4th consecutive year the mortgage-credit institutes achieved a favourable annual result.

In May 1998 the Nationalbank issued a new 1,000-krone note. A new 50-krone note is issued on 7 May 1999. The last in the new series of banknotes will be the new 100-krone note at the end of 1999. Four cash depots were established in Greater Copenhagen in 1998.

The common European payment system, TARGET, entered into force on 1 January 1999. TARGET is designed to ensure rapid and secure transfer of large euro-denominated payments.

In 1998 Danmarks Nationalbank opened an Information Desk, and established a website on the Internet. This gives easier access to statistics and information on the Nationalbank.

Since 1997 the Nationalbank has prepared its systems for the new millennium. The Year 2000 Project comprises review and testing of computer systems and computer hardware, as well as installations and infrastructure. The project is expected to be completed according to plan well before the millennium change.

The Nationalbank's accounts for 1998 show a profit of kr. 5.4 billion. An amount of kr. 1.0 billion - corresponding to the value adjustments - is allocated to the Value Adjustment Reserve, and kr. 1.3 billion - equivalent to 30 per cent of the profit before value adjustments - to the General Reserves. The remainder of kr. 3.1 billion is payable to the central government.