Recent Economic and Monetary Trends

This review covers the period from the beginning of June to mid-September

SUMMARY

Global economic activity has declined strongly over the past year, but seems to have bottomed out, according to several indicators. Many countries pursue highly expansionary fiscal and monetary policies, and the financial markets, as well as consumers and business enterprises, are now more optimistic. Confidence indicators have improved since the spring, and industrial production has ceased to fall in a number of countries. In addition, world trade has begun to stabilise after the sig nificant decrease at the end of 2008. The signs of improvement have led international organisations to make upward revisions of their estimates of growth in the gross domestic product, GDP, in the major economies in 2010. The reversal is fragile, and it is uncertain how the economies will perform once the effects of the expansionary economic policies start to fade.

Output in Denmark was more than 5 per cent lower in the 2nd quarter of 2009 than at end-2007. Confidence indicators have improved recently, retail sales increased from June to July, and output is showing signs of stabilising. The housing market remained weak in the 2nd quarter of 2009, and unemployment continued to rise, while wage inflation slowed down. Annual wage inflation was still higher than abroad, though.

The accommodative fiscal-policy stance in Denmark in 2009 and 2010 and the weak economic activity are expected to lead to considerable government deficits in the coming years. Owing to the size of the gov ernment debt, an even greater fiscal improvement is required for Denmark to be able to tackle the demographically induced increase in the structural budget deficit in future. Further easing of fiscal policy in 2010 will reinforce the need for consolidation due to rising interest costs. Revision of the government's 2015 plan with a view to improving public finances after 2011 would strengthen the credibility of fiscal policy and reduce the risk of higher interest rates in respect of financing of the larger government debt. Furthermore, such a plan would be a natural continuation of the medium-term orientation of the govern ment budgets in the last 12 years.

Danmarks Nationalbank has purchased considerable amounts of foreign exchange in the market over the summer, and the foreign-exchange reserve rose to kr. 374 billion at end-August. Consequently, Danmarks Nationalbank has continued to lower its monetary-policy interest rates, and the lending rate was 1.35 per cent at the beginning of September. The banks have increased their interest-rate margins on corporate lending since the autumn of 2008, and credit standards have been tightened. Total lending by banks and mortgage-credit institutes in Denmark has slowed down, but this is by no means unusual given the very weak demand for credit as a result of the poor economic conditions.

THE INTERNATIONAL ECONOMY

The global economy is recovering from the strongest recession since World War II. After a period of deep recession in late 2008 and early 2009, there are signs that output has bottomed out. The sentiment in the financial markets has reversed as a result of extensive economic-policy stimulus, and consumer and business confidence is slowly re covering.

A common feature of the major economies is, however, that most of the emerging growth in demand can be attributed to the public sector or to government stimulus to demand in the private sector. Fiscal and monetary-policy accommodation is historically large, and there are no signs yet of the major economies entering a period of self-sustaining growth driven by private-sector demand. The reversal is fragile, and it is uncertain how the economies will perform once the economic-policy stimulus is withdrawn over the coming years. Determining the right time for this withdrawal alone represents a major economic-policy challenge.

The recession has hit most countries almost simultaneously due to the international division of labour and the interconnected financial mar kets, but there are differences between the countries in the current eco nomic environment. China and India are again experiencing consid erable economic growth, and in some industrialised countries, including Japan, Germany and France, output picked up a little in the 2nd quarter of 2009, while the decline in output slowed down in many other countries. In the USA, the housing market is showing the first signs of improvement since 2006. Housing prices have stabilised¹, and the num ber of transactions has risen in recent months. Nevertheless, private con sumption in the USA was still weak in the 2nd quarter of 2009. Japan and Germany, economies with a large export content, were hit extra ordinarily hard by the marked decline in world trade at the end of 2008 and the beginning of 2009. Manufacturing and sales of cars especially have decreased but now appear to have stabilised inter alia as a result of the popular subsidies for "scrap and buy new" schemes for cars in many countries. The downturn in world trade has ceased since January, but clear signs of a reversal have not yet emerged.

In the major industrialised economies, business enterprises have cut their production to such an extent that inventories have been consider ably diminished. If inventories are more or less exhausted, it may be necessary to increase production in the near future in order to meet demand. This could contribute to a temporary increase in growth in the coming quarters.

In light of the signs of a global economic recovery, market participants expect economic growth in e.g. the USA, Japan and China in 2010, cf. Table 1, while the outlook for Europe is perceived as weaker. Overall, the economy will pick up slowly and modestly.

Recent quarters have seen strong growth in household savings in many industrialised economies as a result of shrinking wealth and grow ing uncertainty about the economic outlook. In the USA, the household savings ratio has been 4-6 per cent of disposable income in recent months, compared with 1-2.5 per cent in 2005-07. A major share of the fiscal-policy loosening measures directly targeted at the households has resulted in increased savings. The tendency of rising savings is also ob served in European countries, e.g. in the UK, where the savings ratio had fallen to a very low level, and in Germany, where the savings ratio was considerably higher to begin with.

A higher household savings ratio in countries where the ratio had been very low in recent years is a sound trend in structural terms. However, a rising household savings ratio reduces the impact of the current measure to ease fiscal policy. If this trend continues, it will lead to weak devel opment in consumption and to slower economic improvement once public-sector demand normalises. In that case, the economies will have considerable spare capacity for a prolonged period, which will dampen business investment.

Recent lending surveys in the US and the euro area indicate continued tightening of the banks' credit standards, albeit at a slower pace than previously. Demand for credit is decreasing in step with the slowdown in the real economy. In the major economies, lending by the banks as a ratio of GDP does not seem to be falling more than observed in previous recessions.

The labour market is still weak in most industrialised countries, and unemployment continues to rise. In view of the outlook for 2010 with lower-than-normal output, unemployment in many countries is expect ed to grow well into 2010. In the USA, growth in unemployment has slowed during the summer after having increased markedly since the end of 2007. The euro area has seen a substantially less pronounced increase than the USA. Germany in particular has seen only a limited increase in unemployment due to such factors as the widely used "Kurzarbeit" scheme, whereby the government steps in with tempor ary payroll subsidies for reduced working hours.

It is still too early to take stock of the economic effects of the financial crisis in a forward-looking perspective, but some factors already stand out. Firstly, all major economies have experienced a significant drop in output, which was 4-7 per cent lower in the 2nd quarter 2009 than at the onset of the crisis, cf. Chart 1. It will probably take the industrialised economies several years to return to the pre-recession output level. Sec ondly, the crisis has presumably reduced the potential output of the economies, cf. Box 1.

POTENTIAL OUTPUT AND GROWTH	Box 1
Potential output is the output level that is compatible with stable development in wages and prices and normal capacity utilisation. Potential output is determined by the underlying levels of capital and labour and how efficiently capital and labour are used in production. Potential output is not observable, so it must be estimated. The level of and growth in potential output are thus subject to uncertainty. The European Commission, the OECD and the IMF have all made significant down ward adjustments to their estimates of potential output in the USA, the euro area and Denmark in 2009-10 as a result of the ongoing crisis, cf. Table 2. ESTIMATES OF GROWTH IN POTENTIAL OUTPUT, AVERAGE 2009-10 Table 2 Per cent OECD IMF European Commission Pre-crisis Most recent Pre-crisis Most recent Pre-crisis Most recent Euro area 1.9 0.9 2.0* 0.2 1.5 0.7 Denmark 1.0 0.5 2.2 1.5 1.4 0.7 USA 2.3 1.6 2.5 1.2 1.6 1.3 Note: The OECD and the European Commission release estimates every six months, and the IMF releases estimates for the euro area and the USA on an annual basis, while the estimate for Denmark is released every two years. The most recent OECD estimate is from June 2009, while the most recent Commission estimate is from May 2009. The most recent IMF estimates of growth in potential output for the USA and the euro area are from July 2009, and from December 2008 concerning Denmark. *The IMF's pre-crisis estimate of growth in potential output in the euro area covers 2009 only. Source: OECD, IMF and European Commission. The downward adjustments have been motivated by the following factors: Tighter credit standards and more limited access to financing reduce investment. Lower demand and output dampen investment, thereby limiting the size of the capital stock. Reduced research and development activity means lower efficiency gains from the use of capital and labour in production. Rising unemployment is reflected in higher structural unemployment due to the increased risk of long-term unemployment. A reduction in growth in potential output has been observed in previous financial crises. The European Commission and the OECD find it most likely that the growth in potential output will gradually return to pre-crisis levels as the economic conditions improve, cf. the broken yellow line in Chart 2. The faster growth returns to pre-crisis levels, the more limited the loss of welfare due to the crisis will be. There is a risk that the period of low growth in potential output will be prolonged and that growth will not return to its pre-crisis levels, cf. the broken green line in Chart 2. This may be the case if reforms are implemented that are to mitigate the crisis-induced loss of welfare in the short term, but which will permanently reduce labour-market flexibility and dampen growth in the efficiency of capital and labour in production.
POTENTIAL OUTPUT AND ALTERNATIVE SCENARIOS	Chart 2
Note: In the scenario with sustained growth, potential output is projected with the average growth rate in the period 2006-08. In the scenario with growth in potential output, the period 2011-20 will see a gradual increase in growth. After this period, potential output is projected by average growth in the period 2006-08. In the scenario with growth in potential output remaining low, the assumption is that growth will not rise until 2015, and that it will not reach the average pre-crisis level. Source: OECD, Economic Outlook, No. 85, June 2009 and own calculations..

Price developments
Inflationary pressures are continuing to ease in the industrialised coun tries. In the USA and the euro area, consumer prices were lower in July 2009 than in July 2008, primarily due to the high oil and food prices in 2008. Inflation excluding oil and food prices has shown a limited de crease despite the considerable degree of spare capacity in the econ omies. In the USA, consumer price inflation excluding energy and food was around 1.5 per cent year-on-year in the summer of 2009, compared with 2.5 per cent a year before, while the euro area shows a decline from almost 2 per cent in July 2008 to 1.3 per cent in July 2009.

The decreasing consumer prices seem to have affected only the short-term price expectations, while the medium-term and long-term expect ations seem to be well anchored in most countries. The rate of wage increase is declining in the industrialised economies as a result of the weak labour markets. In the USA, wage inflation has dropped to the lowest level in 25 years, and nominal wages are falling in the manufac turing sector. The euro area has seen a relatively strong decrease in wage inflation, mainly attributable to reductions in working hours and flexible wage elements such as bonuses, etc., while declining growth in hourly wages played only a minor role.

Since the effects of the high commodity prices until mid-2008 will abate during the autumn, consumer price inflation is expected to be back in positive territory towards the end of the year. Moreover, commodity prices have surged again since the turn of the year, which will contribute to an upward trend in consumer prices from the autumn. Oil prices have risen from less than 40 dollars per barrel at the turn of the year to around 70 dollars per barrel at the beginning of September. Metal prices also showed considerable increases during the spring, while food prices have been more stable. The main driver of the growth in commodity prices has been strong demand for iron ore, coal and oil in China.

The financial markets
Over the summer, the financial markets have been characterised by stronger confidence in real economic developments, and the extensive political measures have contributed to increasing the risk appetite of investors. Credit spreads in the money and bond markets are ap proaching their pre-crisis levels, stock-market volatility has diminished, and stock prices have risen further since June. These factors imply a significant improvement in financial conditions since the historical low in October 2008, cf. Chart 3. The panic mood has ceased, but the enhanced market stability is to a high degree the result of public support meas ures. Market conditions are still not normalised.

In the autumn of 2008, the emerging market economies saw significant capital outflows due to great uncertainty in the wake of the financial crisis. Throughout 2009, factors such as rising commodity prices and re duced risk aversion have put a stop to the capital outflows from the strongest emerging market economies in Asia and Latin America. How ever, the risk assessment remains relatively high for countries that have been hit particularly hard by the financial crisis, e.g. Iceland and Latvia.

Stock prices worldwide have risen markedly since mid-July following falls throughout June. In mid-September, stock prices in the USA, the euro area and the UK had risen by 8-9 per cent compared with the be ginning of June. The increases have been driven by the investors' more optimistic view on the economic growth outlook. The financial stock indices, which have increased by 14-18 per cent since the beginning of June, were boosted by better-than-expected interim financial state ments from several financial institutions in the USA and Europe, cf. Chart 4. Stock prices in the emerging market economies taken as one have soared in the last six months, by approximately 80 per cent from March to September². The corresponding figure was approximately 50 per cent in the USA and the euro area.

In June, eight major US banks were allowed by the US authorities to repay 68 billion dollars that they had received last autumn under the 700-billion-dollar Troubled Asset Relief Program, TARP. The repayments illustrate the return of a certain degree of stability in the financial sys tem. However, according to the IMF³, banks and other financial institu tions are still facing further write-downs as their losses on loans increase in the wake of the real-economic downturn. The IMF's assessment is that only about one third of the expected write-downs have been made. Up to September, the largest European banks underwent stress tests to measure their ability to weather the economic crisis. The overall object ive of the European stress tests in the financial sector is to assess the sus tainability of the financial sector as a whole.

Since June, 10-year government bond yields in the USA, the euro area and the UK have shown relatively pronounced volatility within a band of 3.2-4 per cent. At the beginning of September, 10-year government bond yields in the USA, the euro area and the UK were 3.4 per cent, 3.3 per cent and 3.6 per cent, respectively. The foreign-exchange markets have been relatively stable over the summer. The euro's exchange rates against the dollar, the yen, the Swiss franc and the pound sterling were almost the same in September as in June. In this period, the Swedish krona strengthened considerably vis-à-vis the euro from a weak level.

Economic policy
The monetary-policy stance continues to be highly expansionary in the major economies. The central banks of the USA, Japan and the euro area have maintained both the low monetary-policy interest rates and the extraordinary measures gradually introduced since September 2008 in order to boost the banks' liquidity and reduce credit spreads in specific markets. The Bank of England and Sveriges Riksbank announced further easing of monetary policy over the summer. On 6 August, the Bank of England announced that it would increase the size of its Asset Purchase Programme by 50 billion pounds, to 175 billion pounds. On 2 July, Sveriges Riksbank lowered the repo rate by 25 percentage points to 0.25 per cent, citing the weak economic development.

Central banks have eased their monetary-policy stance considerably during the crisis. First and foremost, monetary-policy interest rates have been lowered substantially to 0-1 per cent, and in their announcements the central banks have emphasised that the low levels of interest rates will be maintained for a relatively long period. This has pulled market rates further down. Moreover, the central banks have, to a varying degree, introduced unconventional instruments aimed at boosting credit growth by offering ample liquidity to the banks. In addition, the Federal Reserve, the Bank of England and the Bank of Japan and to a lesser extent the European Central Bank, ECB, have purchased bonds in order to ease the situation for specific segments in the financial market.

Overall, monetary-policy interest rates are historically low in the major economies, and the central banks' balance sheets are still strongly ex panded in the late summer of 2009 as a result of extraordinary meas ures, cf. Chart 5. Consequently, the monetary-policy stance cannot be assessed solely on the basis of official interest rates. The central banks' unconventional instruments must also be taken into account. In a num ber of segments in the money and capital markets, interest rates are lower than they would otherwise have been, but this effect is very uncertain, and it is not clear to which extent the ample liquidity has boosted the credit supply.

The global crisis has led to deterioration of public finances worldwide. For the G20 countries taken as one, the budget deficit in both 2009 and 2010 is expected to exceed that of 2007 by 5.5 per cent of GDP. Fur thermore, the debt is expected to increase by approximately 40 per cent of GDP by 2014, an unprecedented increase since World War II.⁴ The fiscal policy pursued during the crisis is described in more detail in the article Impact of Fiscal Policy during the Crisis on p. 77.

NORDIC GOVERNMENT LOANS AND IMF BORROWING PROGRAMMES

In November 2008, the other Nordic countries provided government loan commitments to Iceland tied to Iceland's IMF programme. The loan agreement between Iceland and Denmark, Finland, Sweden and Norway was signed on 1 July 2009. It allows Iceland to borrow up to 1.775 billion euro from the other Nordic countries. The aim is to provide long-term financing for Iceland and to help Iceland strengthen its foreign-exchange reserves during its severe economic and financial crisis. The government loans are linked to the IMF programme for Iceland, and the Nordic loans are paid out in step with payments under the IMF programme. A con dition under the IMF programme is Iceland's compliance with a number of economic-policy terms relating to e.g. fiscal policy, the financial sector and international capital flows. Denmark's share of the Nordic government loans amounts to 480 million euro. On 16 July, Iceland applied for EU membership.

In July, Latvia and the IMF's staff concluded an agreement on a revised economic-policy programme to pave the way for the conclusion of the first programme review under Latvia's programme with the IMF and disbursement of 178 million Special Drawing Rights, SDRs. Under the IMF programme, Latvia has also received loans from the EU and the World Bank among others. Furthermore, the Nordic countries have decided to grant government loans along the same lines as the scheme for Iceland, subject to satisfactory stabilisation policy under the IMF programme. Simultaneously with the agreement on the revised IMF programme, the EU paid out the second tranche of 1.2 billion euro of its loan to Latvia. On 27 August, the IMF's Executive Board approved the conclusion of the first programme review.

As an element of the strategy to enhance global liquidity, on 7 August the IMF's Board of Governors approved the allotment of SDRs to the IMF's member countries for a total of 250 billion dollars. The back ground to the SDR allotment is the declaration of the G20 summit in London on 2 April 2009. The SDR allotment provides an extra buffer that allows countries needing "hard" currency to sell allotted SDRs against currency from a member country with a strong external position. Den mark belongs to the group of member countries with a sufficiently strong currency position that have concluded voluntary agreements with the IMF on trading SDRs for hard currency within agreed limits. SDRs are allotted according to the member countries' IMF quotas with 28 August as the value date.⁵ Consequently, Denmark's SDR allotments have been increased from 178.9 million SDRs to 1.53 billion SDRs.

THE DANISH ECONOMY: MONETARY AND EXCHANGE-RATE CONDITIONS

In recent months, the krone has been stable vis-à-vis the euro at a level close to its central rate in ERM II.

With effect from 14 August 2009, Danmarks Nationalbank lowered the lending rate by 0.1 per cent to 1.45 per cent, the rate of interest on certificates of deposit by 0.1 per cent to 1.35 per cent and the discount rate and current-account rate by 0.1 per cent to 1.10 per cent. The spread between Danmarks Nationalbank's lending rate and the ECB's rate of interest on its main refinancing operations (the monetary-policy interest-rate spread) thus narrowed from 0.55 per cent to 0.45 per cent. The background to the interest-rate reduction was the development in the foreign-exchange market, where Danmarks Nationalbank had been purchasing considerable amounts of foreign exchange for a period.

With effect from 28 August 2009, Danmarks Nationalbank lowered the lending rate by 0.1 per cent to 1.35 per cent. The rate of interest on cer tificates of deposit and the discount rate and the current-account rate were also lowered by 0.1 per cent to 1.25 per cent and 1 per cent, re spectively. The monetary-policy interest-rate spread thus narrowed further to 0.35 per cent. This interest-rate reduction was motivated by continued purchases of foreign exchange in the market, and by end-August the foreign-exchange reserve had grown to kr. 374 billion. Around kr. 10 billion of the increase can be attributed to the SDR allotment.

The spread between money-market interest rates in Denmark and the euro area is somewhat wider than the monetary-policy interest-rate spread, cf. Chart 6. One underlying factor is the very low money-market interest rates in the euro area as a result of the ECB's provision of ample liquidity e.g. via 1-year loans.

In connection with an interest-rate adjustment at the beginning of June 2009, Danmarks Nationalbank introduced a margin of 0.1 per cent between the lending rate and the rate of interest on certificates of deposit. The aim was to give banks and mortgage-credit institutes an incentive to even out mutual liquidity differences via the money market rather than using Danmarks Nationalbank's facilities. The first open market operation with this margin took place on 12 June 2009. From 11 June to the beginning of September, the net position of the banks and mortgage-credit institutes vis-à-vis Danmarks Nationalbank rose by kr. 20 billion, cf. Chart 7. In this period, the institutions reduced their borrowing by kr. 61 billion, while their current-account deposits and holdings of certificates of deposit were reduced by kr. 42 billion in total. The effect of the interest-rate margin is difficult to measure accurately, but since its introduction the banks and mortgage-credit institutes have overall reduced their gross utilisation of Danmarks Nationalbank's facilities.

At the beginning of September, the banks and mortgage-credit institutes had raised loans in foreign currency for kr. 16 billion from Danmarks Nationalbank in connection with the swap lines agreed with the Federal Reserve and the ECB. This is kr. 93 billion less than at the beginning of January. The temporary swap line agreed with the Federal Reserve has been extended until 1 February 2010. From the beginning of June to the beginning of September, Danmarks Nationalbank held three dollar auctions and two euro auctions. The dollar and euro auctions are described in more detail in the article on p. 47.

With effect from 17 July 2009, Danmarks Nationalbank has adjusted the temporary collateral base to include government-guaranteed unquoted bank bonds, etc. The rules for loans based on loan bills as collateral were also amended as of the same date, to include loan bills in the temporary collateral base. Consequently, loan bills can be pledged, without any interest premium, as collateral for all types of krone-denominated loans from Danmarks Nationalbank.

All other things being equal, government capital injections into banks and mortgage-credit institutes under Bank Rescue Package II increase the net position of the banks and mortgage-credit institutes vis-à-vis Danmarks Nationalbank. The deadline for application for government capital injections was 30 June 2009. On this date, 50 banks and mortgage-credit institutes had applied for a total of kr. 63 billion, of which kr. 35 billion had been disbursed. The remainder is planned to be disbursed before the end of the year to institutions that have applied and maintain their applications and also comply with the requirements in the Act on Government Capital Injections into Credit Institutions.

On 10 August, Roskilde Bank, which is being wound up, was trans ferred to the Financial Stability Company by Danmarks Nationalbank and the Danish Contingency Association. In addition to ownership of Roskilde Bank, the Financial Stability Company also took over a sub ordinated loan from Danmarks Nationalbank as well as the credit facility at Danmarks Nationalbank that had been made available to Roskilde Bank.

Bond yields and credit institution interest rates
The 10-year Danish government bond yield was 3.7 per cent at the beginning of September, which is slightly lower than the level at the be ginning of June. In the same period, the maturity-adjusted yield spread between Danish and German 10-year government bonds narrowed a little to 0.25 per cent.

Short-term and long-term Danish mortgage-credit bond yields have declined by 0.4 and 0.2 per cent, respectively, since the beginning of June and were 2.1 per cent and 5.2 per cent at the beginning of September, cf. chart 8. The low short-term yields and a steeper yield curve are the reasons why new issuance is mostly in non-callable fixed-rate bullet bonds ("fixed bullets"). As a result, the fixed-bullet auctions in December 2009 will involve large amounts, cf. the article Danish Mortgage-Credit Bonds during the Financial Turmoil on p. 51.

Retail interest rates have been reduced concurrently with Danmarks Nationalbank's reductions of the monetary-policy interest rates, al though not on a one-to-one basis, cf. Chart 9. From November 2008, when Danmarks Nationalbank began to lower its monetary-policy inter est rates, until July 2009, the banks' average lending rates to households and the corporate sector declined by 2.7 per cent and 2.8 per cent, re spectively, while the deposit rates fell by 2.3 per cent and 3.1 per cent. A number of banks have announced their intention of reducing retail interest rates in September, citing Danmarks Nationalbank's most recent interest-rate reductions. However, Cibor is the yardstick for a large part of the banks' corporate lending.

Danish retail interest rates have largely mirrored retail rates in the euro area. In recent months, the main drivers of the development in the spread between lending rates to the corporate sector in Denmark and the euro area have been the monetary-policy interest-rate spread and the spread for uncollateralised money-market interest rates.

The interest-rate margin on corporate lending declined from June to July, cf. Chart 10, but is higher than in the autumn of 2008. The widening of the interest-rate margin can be attributed to several fac tors. The financial crisis has led to larger write-downs and losses, chiefly on corporate exposures. In addition, the risk premium on corporate lending has increased due to the weak economic development. More over, payment for the government guarantee under Bank Rescue Pack age I plays a role, and the financial crisis has generally made it more expensive for the banks to raise financing in the money and capital markets. According to Danmarks Nationalbank's lending survey, higher financing costs have been a contributing factor to the tightening of credit policies to the corporate sector since the 3rd quarter of 2008. The widening of the interest-rate margin should also be viewed against the backdrop of the need for consolidation in the banking sector with larger reserves and capital.

Credit developments

Total growth in lending to households and the corporate sector by banks and mortgage-credit institutes located in Denmark has continued its downward trend in recent months and was around 3 per cent year-on-year at the end of July. The banks' seasonally-adjusted lending to households has been decreasing since the end of 2008, whereas corporate lending has been relatively stable since May 2009 after having fallen in the preceding period, cf. Chart 11. Lending by the mortgage-credit institutes has continued to rise throughout the period. Conse quently, a substitution is observed from bank credit to mortgage credit.

Lending patterns in Denmark have several features in common with patterns in a number of other European countries, which also showed strong credit growth until 2008, followed by a slowdown, cf. Chart 12. The slowdown, particularly in corporate lending, has given rise to a discussion of whether the banks have reduced the supply of credit con siderably more than the weak economic development would warrant, making it difficult for creditworthy borrowers to obtain financing. A credit crunch of this nature will as such have a dampening effect on eco nomic development.

The assessment of whether a general credit crunch exists encompasses an analysis of various aspects of lending by banks and mortgage-credit institutes, including data on the actual development in credit and on how the banks and business enterprises assess the credit situation.

The decrease in the banks' corporate lending can be attributed primarily to drawings on overdrafts, which amount to around 40 per cent of outstanding corporate loans and have fallen by around kr. 48 billion since the turn of the year.⁶ This is undoubtedly due to a combination of tighter credit standards and reduced demand. It should be borne in mind that, with effect from February, the deadlines for business enterprises' payment of VAT, income tax and labour-market contributions were extended. This is estimated to have had a liquidity effect of approximately kr. 50 billion. The gradual phasing-out of this scheme until the turn of the year will have a corresponding burdening effect on corporate liquidity.

The development in GDP is an indicator of the transaction and financing requirements in the economy. The development in corporate credit has not been extraordinarily weak, given the economic trends. Viewed over a longer period, the recent weak development in credit has not been unusual, cf. Chart 13. Recent years have seen strong growth overall in lending as a ratio of GDP, which is currently at a high level. Decreases in lending as a ratio of GDP were also observed in previous periods, e.g. in the early 1990s, when the banks' earnings were also under pressure.

In addition to credit from banks and mortgage-credit institutes, other sources of financing for business enterprises include bond financing, loans from other enterprises, supplier and commercial credits as well as tax owed, etc. During 2008 and the 1st quarter of 2009, total credit to the corporate sector rose from 106 to 124 per cent of GDP. The rela tionship between total borrowing from banks and mortgage-credit insti tutes and other borrowing has been almost unchanged.

Danmarks Nationalbank's lending survey throws light on the devel opment in the credit institutions' lending policies and thus on the extent to which lending is driven by supply factors. After significant tightening of credit standards to the corporate sector in two quarters, conditions in the 2nd quarter of 2009 were almost unchanged from the 1st quarter, cf. Chart 14.

The lending survey shows quarter-on-quarter changes. In spite of the net response to the effect that credit standards were not tightened to any significant degree in the 2nd quarter of 2009, this should be viewed against the backdrop of the substantial tightening in the previous quar ters, which is still in effect.

Given the economic slowdown, it is natural for the banks and mortgage-credit institutes to have tightened their credit standards to reduce the risk of losses on loans. The most significant underlying factor is the credit institutions' risk assessments, reflecting their assessments of the creditworthiness of borrowers, including the economic develop ment. The risk appetite of the credit institutions has also played a role.

According to the lending survey, the tightening of credit standards by banks and mortgage-credit institutes has affected the conditions for corporate lending, resulting in e.g. higher prices and more stringent col lateral requirements. The banks' total interest-rate margin has indeed widened since the autumn of 2008, after having narrowed over a re latively long period. An equivalent widening was seen in the early 1990s when the banks also suffered substantial losses. The collateral require ments are furthermore reflected in the substitution from bank loans to mortgage-credit loans.

Moreover, the lending survey provides information on the respond ents' assessment of the development in the demand for loans. The insti tutions, particularly the banks, have reported falling demand for loans, which is consistent with the cyclical picture.

The business enterprises' assessment of the credit situation is another source of information on the supply and demand factors driving lend ing. On the basis of Statistics Denmark's confidence indicators, only a small share of the enterprises in the sectors of industry and building and construction state financial constraints as impediments to production, while insufficient demand is increasingly stated as a reason, cf. Charts 15 and 16.⁷ This is consistent with Danmarks Nationalbank's lending survey.

Overall, the banks have tightened credit standards and increased their interest-rate margins, but this should be viewed in light of the too leni ent credit standards before the crisis. In recent years, lending by banks and mortgage-credit institutes has risen strongly in relation to output and is now at a high level, viewed over a longer period. A downward adjustment would not be unusual and has been observed previously. At the same time, credit constraints have not been a significant impedi ment to production, and investment demand is very weak as a result of considerable spare capacity in terms of both the capital stock and the housing stock. These factors generally do not constitute sufficient evi dence of a general credit crunch.

Previous business cycles in Denmark have shown that a credit squeeze does not to any significant degree impede an emerging upswing, since the business enterprises normally use retained earnings as a source of financing at the beginning of an upswing.⁸ The demand for credit does not rise until late in the business cycle when the existing production capacity has been exploited and the business enterprises' own reserves are insufficient to finance expansion of the capital stock.

The Danish economy, including the financial system, is going through an adjustment process whereby unprofitable business enterprises will disappear. The process is accompanied by friction in the financial system. Some credit institutions may opt for consolidation in order to build up reserves to cover higher capital requirements in the future imposed by new international standards. The credit institutions are adjusting their credit standards and have expanded their margins vis-à-vis a number of business enterprises. At the same time, it has become more difficult to change banks. This has weakened competition in the financial system. As a result of the adjustment, both credit institutions and other business enterprises will have to reduce their leveraging. The situation and the strength of the friction may differ, however, between credit institutions or segments. This warrants continued monitoring of the development in creditworthy business enterprises' access to financing.

THE DANISH ECONOMY: REAL ECONOMY

Economic activity
Economic activity in Denmark has slowed down since the end of 2007. In the 1st quarter of 2009, GDP fell by 1.1 per cent, and confidence indi cators point to a further drop in the 2nd quarter of 2009, when output is expected to be more than 5 per cent lower than the level at end-2007.⁹The output loss has thus been on a par with that of Denmark's major trading partners.

Although output started to decline a little earlier in Denmark than abroad, there are no signs that Denmark will experience a reversal sooner – on the contrary. Nevertheless, output seems to have bottomed out also in Denmark, as evidenced by the recent improvement or sta bilisation of confidence indicators.

Industrial and service enterprises have become less pessimistic in recent months. In August, however, the number of enterprises expecting falling employment and sales in the near future was greater than the number of enterprises expecting growing employment and sales. Industrial production has declined by around one fifth over the last year and was at a 10-year low in the summer of 2009. Cyclical products such as elec trical equipment, textiles and components for manufacturing transport equipment have shown the strongest drops, while less cyclical products such as pharmaceuticals and food have been more stable. Sales of in dustrial goods to the domestic market have stabilised in recent months, while export market sales have risen, cf. Chart 17. The latest rise in ex port market sales reflects an emerging stabilisation of the international economy, including growth in industrial production in some of Den mark's major trading partners in recent months.

The decrease in industrial production is probably to some extent attributable to inventory reduction. This view is supported by the inven tory reduction in industry and wholesale trade in the 2nd quarter of 2009, which was the largest since 1987, when Statistics Denmark began to compile inventory statistics.

The business enterprises' spare capacity has grown in step with the fall in industrial production, cf. Chart 17. This has reduced the need for in vestment in new machinery, buildings, etc., and business investment has decreased substantially since 2007.

The confidence indicator for the construction sector has stabilised in recent months at a considerably lower level than normal, indicating continued widespread pessimism. Employment in this sector declined in the 1st half of 2009, and unemployment rose fast to around 11 per cent of those with unemployment insurance in July. It has taken until recent months for the shortage of labour in construction to be completely outweighed. Public-sector investments and subsidies for renovation of owner-occupied homes have been initiated to boost activity in con struction.

Consumer confidence has improved notably over the last six months, but was still negative in August. Consumer sentiment is reflected in retail sales, which continued to fall in the 1st half of 2009, albeit at a somewhat slower pace than in the 2nd half of 2008. Seasonally adjusted retail sales rose by 1.0 per cent from June to July 2009, which was the strongest growth month-on-month since December 2007. The disburse ment of previously frozen Special Pension savings may have contributed to the increase.

Car sales to households also declined in the 2nd quarter of 2009, when they were no less than 40 per cent below the level in the 2nd quarter of 2008, cf. Chart 18. Seasonally adjusted car sales to households were un changed from June to July 2009. The drop in retail sales and car sales in the 2nd quarter of 2009 indicates that private consumption also de creased compared with the previous quarter. If this holds true, the 2nd quarter of 2009 will be the fifth consecutive quarter with falling private consumption. The downward trend in private consumption has coin cided with growing household disposable income as a result of wage growth and tax cuts, thereby increasing private savings to a high level. In August, the Danish Ministry of Finance estimated that household real disposable income will rise by 3.1 per cent in 2009 and 4.4 per cent in 2010. Add to this the Special Pension savings disbursements.

The housing market
The housing market remained weak in the 1st half of 2009. The national average for house prices fell by 5.9 per cent in the 1st quarter of 2009 and was thus 15 per cent lower than in the same quarter of 2008, ac cording to Statistics Denmark. The statistics of the Association of Danish Mortgage Banks indicate that the downward trend in housing prices continued in the 2nd quarter of 2009, but at a slower pace than in the 1st quarter. Prices of owner-occupied flats have declined even faster over the last year and had fallen by almost 19 per cent in the 1st quarter of 2009 compared with the 1st quarter of 2008, according to Statistics Denmark. The statistics of the Association of Danish Mortgage Banks also indicate a further fall in prices for owner-occupied flats in the 2nd quarter. Housing prices have declined in all regions in Denmark over the past year, but most markedly in the Copenhagen region, where prices declined by just over one fifth on average from the 1st quarter of 2008 to the 1st quarter of 2009.

Seasonally adjusted asking prices have been almost unchanged during the summer. However, normalisation of the housing market requires re newed growth in the number of transactions. In the 2nd quarter of 2009, seasonally adjusted turnover was still very low, cf. Chart 19.

Foreign trade and balance of payments
Foreign trade has begun to stabilise after the strong drop at the end of 2008. The decline in exports and imports of goods excluding ships and aircraft slowed down in the first five months of 2009, and the period May-July 2009 saw a weak increase in seasonally adjusted exports, cf. Chart 20. The improvement is also indicated by the industrial enterprises' outlook on the order intake from export markets, which has become slightly less pessimistic in recent months compared with the beginning of the year.

TImports of goods have declined a little faster than exports in 2009, implying a small increase in the monthly trade surplus from an average of just over kr. 3 billion in 2008 to just over kr. 4 billion in the first seven months of 2009. The surplus on trade in services, including sea freight, has fallen in 2009 as a result of the slowdown in world trade and lower freight rates. The lower surplus on the balance of services has been more than outweighed by higher net earnings on trade in goods and investment income, causing the current-account surplus to increase. In the first seven months of 2009, the surplus totalled kr. 21.6 billion, which is 3.8 billion more than in the same period of 2008.

Labour market, wages and prices
The labour market, which typically follows cyclical developments with a lag, is still weakening. According to the ATP employment indicator, employment declined by a total of 105,000 full-time equivalents from the peak in the 1st quarter of 2008 to the 2nd quarter of 2009. Un employment rose by approximately 57,000 full-time equivalents from the trough in June 2008 to July 2009, when seasonally adjusted unem ployment was 103,300, or 3.7 per cent of the labour force. The increase has brought unemployment closer to the estimated structural level, but the rate of growth has slowed down in recent months.

The labour force, i.e. the sum of employees according to the national accounts and unemployed according to the unemployment statistics, fell by 35,000 from the 1st quarter of 2008 to the 1st quarter of 2009. The fall reflects that more people are retiring from the labour market due to the poorer employment opportunities.

The number of new job advertisements on the Internet has fallen back to the 2004 level, and more employees share a job today than a year ago; these two factors also reflect the poorer employment opportun ities. According to the Danish Labour Market Authority, approximately 6,500 people were in job sharing schemes¹⁰ in July 2009, against ap proximately 232 in July 2008.

The dampened pressure on the labour market has contributed to a lower rate of wage increase. According to Statistics Denmark, annual wage inflation in the private sector declined to 3.0 per cent in the 2nd quarter of 2009, compared with 4.6 per cent in the 2nd quarter of 2008. The relatively low wage inflation in the 2nd quarter of 2009 partly reflects the more prolonged local wage bargaining compared with pre vious years. Consequently, wages and salaries have remained unchanged in the statistics for the 2nd quarter for a relatively higher number of employees. Moreover, the local bargaining concluded has resulted in a very large number of zero adjustments this year. Finally, nuisance bonuses have declined relative to the 2nd quarter of 2008 due to the re duction in overtime, night and weekend shifts.

In the highly competitive manufacturing sector, wage inflation de creased to 2.7 per cent year-on-year in the 2nd quarter of 2009, accord ing to Statistics Denmark. This is still higher than abroad, however, cf. Chart 21. In addition, the continued strong effective krone rate has weakened wage competitiveness further in the first part of 2009. The higher wage inflation in Denmark indicates that pressures on the labour market have remained stronger than in most of Denmark's competitor countries in export markets.

Annual wage inflation in the public sector has remained high in the first part of 2009. In the 2nd quarter of 2009, wage increases for local and regional government employees were 7.4 per cent compared with the 2nd quarter of 2008. Central government employees saw wage increases of 4.6 per cent year-on-year, against 6.7 per cent year-on-year in the 1st quarter of 2009. The strong wage increases reflect such factors as the 2008 collective agreements, under which most of the general wage increases were to be implemented within the first year. Moreover, the conflict in the healthcare sector meant that the wage increases in some of these areas were not implemented until the 3rd quarter of 2008. Wage inflation in the public sector is thus expected to decline in the remainder of the collective agreement period.

Consumer price inflation, measured as the annual increase in the HICP, was 0.7 per cent in August. The low inflation in August is chiefly attrib utable to lower energy and food prices compared with August 2008. The low inflation and simultaneous wage growth have resulted in a stronger increase in real wages in 2009 relative to 2008.

In the euro area, annual HICP inflation was -0.2 per cent in August 2009 according to preliminary statistics. The trend, observed since mid-2008, of higher consumer price inflation in Denmark than abroad thus continues. Core inflation, which excludes food and energy prices, has been relatively stable at around 2 per cent year-on-year over the last year, i.e. a higher rate than in the euro area. This also indicates stronger capacity pressures in Denmark than in our largest trading partner area. The continued price pressures in Denmark are underpinned by the notable increase in domestic market-determined inflation, IMI, over the past year, to more than 6 per cent year-on-year in July. IMI is a measure of the price increases attributable to payrolls and profits of Danish busi ness enterprises.

The significant pressures on the Danish labour market during the last boom resulted in higher wage increases that were not accompanied by corresponding productivity increases. Consequently, corporate profits were squeezed, and the business enterprises' share of total income generation in the economy, i.e. the profit ratio, declined. 2007 and 2008 saw a decrease in productivity, according to the available national accounts. A dampening of productivity growth is normal in the last phase of a boom, but the recent dampening has been more pronounced than previously. Productivity growth is expected to rise again in the coming years, resulting in partial recovery of the profit ratio. Since the capacity utilisation in the economy is low at the outset, and since relatively weak productivity growth is expected in the coming years, this implies a continued fall in employment and rising unemployment this year and next year.

Economic policy
Output is expected to bottom out in 2009, followed by a slow increase. Annual output growth is expected to reach 1.7 per cent in 2011, cf. the article The Danish Economy 2009-11, p. 33. Fiscal policy contributes to increasing demand, both automatically and as a result of e.g. the in crease in unemployment benefits in step with the rise in unemployment. Discretionary expansion of fiscal policy also plays a role. Income taxes will be lowered in both 2009 and 2010, while public investment is in creased due to higher traffic investments and local government fixed investments. Local government investments were brought forward in 2009, and in connection with the agreement between the government and Danish Regions and Local Government Denmark on the 2010 budgets, local government investments were raised compared with the 2009 level. Other factors are renovation subsidies and extension of dead lines for corporate payments of VAT, income tax and labour-market con tributions.

Denmark's relatively low government debt compared with other coun tries has given Denmark a good foundation for supporting economic activity in the current recession. However, loosening of fiscal policy puts public finances under pressure, resulting in a reversal of recent years' sound budget surpluses to considerable deficits. The government budget deficit is expected to be 2.2 per cent of GDP in 2009, 5.6 per cent in 2010 and 4.6 per cent in 2011.

Owing to the size of the government debt, an even greater fiscal im provement is required for Denmark to be able to tackle the demo graphically induced increase in the structural budget deficit in future. Further easing of fiscal policy in 2010 will reinforce the need for con solidation due to rising interest costs. Revision of the government's 2015 plan with a view to improving public finances after 2011 would strengthen the credibility of fiscal policy and reduce the risk of higher interest rates in respect of financing of the larger government debt. Furthermore, such a plan would be a natural continuation of the medium-term orientation of the government budgets in the last 12 years.