Recent Economic and Monetary Trends

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

Global economic growth is declining amidst continued uncertainty in the wake of the financial turmoil. The USA shows weak economic development, while the euro area has performed better than expected at the beginning of the year. Sound output growth is still predicted in the emerging market economies. Overall, the latest international cyclical analyses are less negative than earlier this year.

Despite the slowdown in growth, inflation is high in most of the world since consumer prices have been pushed upwards by rising food and energy prices. Although in the longer term improved supply of especially food can be assumed to stabilise the development in prices, there is a risk of a sustained increase in inflation expectations. This risk limits the scope for economic-policy expansion in the USA and Europe.

Denmark has also seen a slowdown in growth, and this trend will continue in the coming years. Employment remains high and there is a pronounced shortage of labour. The rate of wage increase is significantly higher than that of Denmark's trading partners, and output is high in relation to the capacity of the Danish economy. Lower growth and higher unemployment are prerequisites for sustainable development in wages and prices in the longer term. Weaker export-market growth is a useful contribution to this sustainable development.

The rising food and energy prices have caused consumer prices to soar, also in Denmark. If the current substantial price increases create expectations of continued high inflation, this could trigger a wage and price spiral to the detriment of the already strained wage competitiveness. The strong pressure on the labour market makes it imperative not to ignore the risk of rising inflation expectations. Irrespective of the current dampening, it is important that fiscal policy in 2009 does not stimulate demand.

THE GLOBAL ECONOMY

Global economic growth is declining, although the outlook is a little less negative than earlier this year. The April forecast by the International Monetary Fund, IMF, expected a pronounced slowdown in growth in 2008, but more recent forecasts from the European Commission and the OECD paint a more positive picture. The relatively robust economic development outside the USA in the first months of the year and a more favourable view of the extent of the financial turmoil have given rise to a less negative growth outlook. The substantial divergence between the forecasts illustrates that great uncertainty prevails concerning the macroeconomic consequences of the financial turmoil and the continued considerable increases in food and commodity prices. The slowdown in growth is most pronounced in the USA and less in other industrialised countries. The emerging market economies, on the other hand, have remained almost unaffected by the turmoil, cf. Table 1.

The turmoil in the financial markets
The turmoil in the financial markets, which began in 2007 in connection with the subprime crisis in the US housing market, peaked in mid-March 2008. The US investment bank Bear Stearns, which had suffered large losses, was affected by confidence problems and was acquired by the major US bank JP Morgan Chase & Co., with support from the Federal Reserve. As a result of this situation, the yield on safe assets such as government bonds was pressed down to a low during the turmoil. The willingness of the US authorities to contribute to the rescue of an investment bank dampened the uncertainty in many financial markets. The yield on US 10-year government bonds has increased by 0.6 percentage point since mid-March, to 3.9 per cent. A similar increase in government-bond yields was observed in Europe.

Uncertainty in the money markets is still notably greater than before the outbreak of the turmoil, cf. Chart 1, and many central banks continue to introduce new, extraordinary measures to improve the functioning of the money markets. In the period since August 2007 the central banks of the USA, the euro area, the UK and Switzerland, among others, have provided extra liquidity and offered special facilities, e.g. extended access to borrow and easier access to liquidity, in order to compensate for the poor functioning of the money markets.

Since the beginning of March, the Federal Reserve and the Bank of England have made additional facilities available.^[1] These measures have mainly been aimed at expanding the collateral base and extending access to loans with longer maturities than normal. In order to facilitate foreign banks' access to dollar funding outside the USA, the Federal Reserve's swap facilities with the European Central Bank, ECB, and the Swiss National Bank from December 2007 have been extended. This agreement has made it easier for banks and other market participants to obtain dollar funding during the financial turmoil.

The uncollateralised money-market interest rate is still considerably higher than the collateralised interest rate. The US spread between collateralised and uncollateralised interest rates has fluctuated strongly in recent months, but has narrowed to 0.8 percentage point since the end of April. The interest-rate spreads in the European markets have been relatively stable around this level in the same period, cf. Chart 1.

According to bank lending surveys, credit terms were tightened further in the 1st quarter of 2008 in both the USA and the euro area. This applies to corporate lending as well as lending to households. The tightened credit terms have dampened growth in housing loans in both the USA and the euro area, while growth in bank lending to business enterprises and other lending to households has remained high. The continued growth in corporate lending partly reflects that drawings on bank credit facilities have replaced issuance of corporate bonds.

According to IMF statistics from April 2008, the risk elements in the financial markets are more pronounced and the fundamental monetary and financial market conditions are less positive than in 2007, cf. Chart 2. At the same time, the risk appetite among investors has decreased considerably.

In the autumn of 2007, the G7 countries asked the Financial Stability Forum, FSF^[2], to prepare an analysis of the causes and underlying weaknesses in the financial system that have contributed to the turmoil, and to make specific recommendations and proposals for enhancing the resilience of the financial markets and institutions.The FSF published its report on 11 April. It points to shortcomings in financial enterprises' risk management, poor performance of credit rating agencies in respect of structured credit products and weaknesses in the financial supervision system as some of the factors that have contributed to the turmoil. In five key areas the FSF has made a number of recommendations aimed at financial enterprises, governments, supervisory authorities and central banks. The objective is to prevent a similar situation from occurring in the future. Central banks are encouraged to ensure flexible credit facilities, and the report also emphasises the importance of central banks having a broad collateral base and a large group of counterparties and offering longer-term loans. The conclusions of the report and the FSF's recommendations are summarised in Box 1.

The G7 finance ministers and central-bank governors have committed themselves to implementing the key recommendations. This will be done in two steps, i.e. the most urgent measures are to be implemented by the end of July 2008, while selected other recommendations are to be implemented by the end of 2008.^[3]

The stock and foreign-exchange markets
The stock markets have been affected by the prospects of lower growth and the financial turmoil, cf. Chart 3. Stock prices plummeted to a low in March when the unrest concerning the Bear Stearns investment bank peaked. Uncertainty has declined since then, and by the beginning of June stock indices in the USA, the euro area, the UK and the emerging market economies had risen by 8-14 per cent from the low in March.

The euro appreciated vis-à-vis a number of currencies in March and early April, cf. Chart 4. It appreciated particularly strongly against the US dollar and the pound sterling, which should be viewed in the light of interest-rate cuts in the USA and the UK. The euro's strength had abated a little at the beginning of June.

Surging commodity prices
Commodity prices, including oil and food prices, have surged and have contributed to high consumer-price increases worldwide in 2008.

At the beginning of June, the oil price was just under 130 dollars per barrel (Brent), cf. Chart 5. This represents an increase by almost 40 per cent since the beginning of the year, which is attributable to several factors. Firstly, high economic growth has led to stronger demand for oil in the emerging market economies. In these economies, oil consumption is often subsidised or subject to price adjustment (e.g. in China), which cushions the spillover effect of higher oil prices on consumer prices. Secondly, there have been indications of limited growth in the supply of oil in the form of both OPEC's reluctance to increase production and geopolitical tensions. Finally, a part of the oil-price increase represents compensation for the weakness of the dollar. The oil price increases have been considerably lower measured in euro.

In recent months, the soaring food prices have given rise to social unrest and a pronounced fall in living standards in a number of poor countries where food consumption accounts for a large share of income.

The higher prices were most pronounced in food categories such as grain, oil seeds, dairy products and most recently rice, cf. Chart 6. A combination of factors has led to higher demand, lower supply and higher production costs. Global demand for food is rising as a result of population growth and increased prosperity. The production of biofuel has also played a role as subsidies have pushed demand for maize, sugar, wheat and oil seeds upwards. According to an estimate from the international think tank, International Food Policy Research Institute^[4], greater demand for biofuel in the period 2000-07 has accounted for 30 per cent of the average increase in crop prices. Estimates of the contributions of the individual factors are relatively uncertain, however, and there is great dispersion between the existing estimates. On the supply side, the agricultural land allocated to grain, oil seeds and rice has been reduced by 7.5 per cent since 1997 in the industrialised countries. Poor harvests have resulted in lower yields in 2005 and 2006, leading to a reduction of global stocks. Higher fertiliser and sea freight prices have also contributed to the rise in food prices. On the other hand, several international organisations and public authorities have all denied that speculation has played any considerable role in the price surges. An OECD and FAO report from May on the outlook up to 2017^[5] expects food prices to subside a little from the current record-high levels, but to remain high as a result of the growing demand for biofuel and from emerging market economies such as China. Increase of the food supply in response to the high prices would help to curb the growth in food prices.

Metal prices have also risen steeply since the beginning of 2008. The principal reasons are growing demand from the emerging market economies, notably China, and sluggish expansion of the production capacity.

Consumer surveys show that perceived inflation over the last year and expectations of price increases in the coming year have risen since the summer of 2007 in both the USA and the euro area. The surging energy and food prices have no doubt played an important role in this connection. The development entails a risk of higher inflation expectations and a possible wage and price spiral, which would limit the scope for continued easing of economic policy in the USA and the euro area.

INTERNATIONAL ECONOMIC DEVELOPMENT

USA
According to preliminary data, GDP growth was 0.2 per cent in the 1st quarter of 2008, which was almost unchanged from the 4th quarter of 2007 when the full effect of the slowdown in the US economy was observed. The low growth reflects slightly rising private consumption and continually falling investments, driven especially by residential investments. Buoyed up by the weaker dollar, net exports made a slightly positive contribution to growth in the quarter. Employment in the non-agricultural sector has declined steadily throughout 2008. Unemployment has risen since the spring of 2007, to 5.5 per cent of the labour force in May 2008.

The housing market is ailing. House prices have dropped further, and residential investments have decreased considerably. The US administration has launched a number of initiatives to help homeowners, and further proposals have been tabled, cf. Box 2. US households receive 100 billion dollars in May and June as an element of the US administration's assistance package totalling 150 billion dollars, corresponding to approximately 1 per cent of GDP. The tax deductions for investments are increased to the extent of 50 billion dollars. Higher disposable incomes are expected to stimulate demand, primarily in the 2nd and 3rd quarters of 2008.

The Federal Reserve has lowered the fed funds target rate by a total of 2.25 percentage points in 2008, most recently on 30 April, when the target rate was reduced by 0.25 percentage point to 2.0 per cent. The interest-rate cuts will stimulate demand.

Annual consumer price inflation decreased to 3.9 per cent in April after having remained at above 4 per cent since November 2007, despite stagnating demand. The strong price inflation is partly attributable to food and energy prices, but also to the weaker dollar via higher import prices.

Europe
The euro area has seen relatively robust growth, i.e. GDP growth of 0.8 per cent in the 1st quarter of 2008. Germany's record-high quarter-on-quarter growth rate of 1.5 per cent boosted overall growth in the euro area. The strong performance in Germany primarily reflects increased investments rather than higher private consumption, while the growth contribution from net exports was slightly negative. There are thus emerging signs that domestic demand is taking over from exports as the main driver of economic growth in Germany. France also showed a sound GDP growth rate in the 1st quarter, whereas the Southern European countries experienced somewhat lower growth rates.

Developments in the labour market continue to be positive, and unemployment remained at 7.1 per cent in the first three months of the year. Looking forward, confidence indicators of both output and house hold consumption, however, point to a dampening in the euro area.

Recent months have seen weak retail sales and continued high industrial production. The influx of new orders in the industrial sector, including export orders, has declined. Although international organisations predict an overall slowdown in growth in the euro area in 2008 and 2009, it is expected to be weaker than in the USA, cf. Table 1. Inflation in the euro area has exceeded 3 per cent since November, primarily driven by surging food and energy prices. Annual inflation is expected to remain above 3 per cent overall in 2008. The ECB has maintained its key interest rate at 4 per cent since June 2007.

In the UK, growth declined to 0.4 per cent quarter-on-quarter in the 1st quarter of 2008, while consumer price inflation rose to 3.0 per cent year-on-year in April. On 10 April, the Bank of England lowered the bank rate, for the second time in 2008, by 0.25 percentage point to 5.0 per cent. The Bank of England's latest inflation report expects inflation to exceed the upper target of 3 per cent in the coming quarters. Should this be the case, the governor must write an open letter to the Chancellor of the Exchequer, describing the excessive inflation and the measures that will be implemented to bring inflation back within the interval. The most recent open letter was written in April 2007 on account of the 3.1 per cent inflation figure compiled in March.

Among the Nordic countries, on 23 April Norges Bank raised its key policy rate by 0.25 percentage point to 5.5 per cent, while Sveriges Riksbank has maintained its repo rate unchanged at 4.25 per cent.

The Icelandic krona has depreciated strongly against most currencies, and the effective exchange rate has weakened by more than 20 per cent since the autumn of 2007. The depreciation has led to higher inflation in Iceland, and in March and April Seðlabanki Íslands raised its policy rate by a total of 1.75 percentage points to 15.5 per cent. Iceland is experiencing not only rising inflation, but also an economic downturn after several years of a booming economy with rising housing prices.

The imbalances in the Icelandic economy have been reinforced by the fact that the Icelandic banks' strong expansion abroad has made them dependent on foreign financial markets. The turmoil in the international financial markets has entailed considerably higher financing costs for the banks, and the yield on Icelandic government bonds rose substantially during March.

Against this background, Danmarks Nationalbank, Norges Bank and Sveriges Riksbank concluded bilateral agreements in mid-May for a swap facility with Seðlabanki Íslands, offering the latter a credit facility of up to 1,500 million euro equally distributed among the three central banks, should this be required for financial stability purposes. On the same occasion, the Icelandic government announced its intention to implement structural reforms, present a plan for restructuring and reform of the state-owned mortgage-credit system, maintain a low level of government debt and strengthen the fiscal framework. The Icelandic krona has stabilised after the announcement of the agreement, and the CDS spread (the price of insurance against credit risk in Icelandic banks) has narrowed, but remains high.

Emerging market economies
The emerging market economies are still growing at a robust pace, but high inflation is a key challenge in many countries. In most countries, inflation is driven by food prices due to the larger food component in their price indices. These economies have only to a limited extent been affected by the financial turmoil, but they are facing a number of real economic challenges triggered by the slowdown in the industrialised countries, combined with inflationary pressures and strong domestic demand.

In China growth declined a little throughout 2007, but remains high. GDP growth was 10.6 per cent in the 1st quarter of 2008, compared with the same quarter of 2007. The decline is primarily attributable to weaker export dynamics, while growth is buoyed up by strong domestic demand in the form of investments and increasingly by private consumption. Inflation is a mounting concern, having risen from around 3 per cent at the beginning of 2007 to 8.5 per cent in April 2008.

In India GDP growth subsided gradually during 2007 in the wake of a number of measures to tighten monetary policy. In the 1st quarter of 2008, GDP grew by 8.8 per cent year-on-year compared with an annual growth rate of 9.2 per cent in 2007. After a downward trend in the 1st half of 2007, recent months have seen a marked increase in inflation measured in terms of wholesale prices.

THE DANISH ECONOMY: MONETARY AND EXCHANGE-RATE CONDITIONS

The money and foreign-exchange markets
The Danish krone has been stable around its central rate in ERM II. The krone weakened a little from the middle of January and was slightly weaker than the central rate against the euro at the end of April and the beginning of May. The weakening can be attributed to the narrowing of the short-term yield spread to the euro area in the light of the turbulence in the money markets.

Since the international financial turmoil spilled over into the money market of the euro area, the banks' demand for liquidity in the ECB's weekly tenders has grown. As a result, the ECB's marginal rate has normally been somewhat higher than the minimum bid rate. The spread between Danmarks Nationalbank's lending rate and the ECB's marginal rate narrowed by 0.15-0.2 percentage point from August 2007 until mid-May 2008, and was thus virtually non-existent, cf. Chart 7. It was even negative for short periods. Danmarks Nationalbank intervened in the foreign-exchange market to purchase kroner against foreign exchange for around kr. 20 billion from the beginning of April to mid-May, and the lending rate and the rate of interest for certificates of deposit were raised from 4.25 per cent to 4.35 per cent on 16 May. The discount rate and the current-account rate remained unchanged at 4.0 per cent. The foreign-exchange reserve was kr. 162 billion at end-May. After the interest-rate increase the spread between Danmarks Nationalbank's lending rate and the ECB's marginal rate widened, and the krone strengthened.

As a consequence of the turbulence in the money markets, the euro-kroner interest-rate spreads for different products showed diverging patterns, cf. Chart 8.

Since the beginning of March, a forward discount has predominantly applied to trading euro against kroner, as opposed to the forward premium usually applicable to such trading, cf. Box 3. This has resulted in a negative implied yield spread for FX swaps between kroner and euro. Owing to the forward discount, residents have been less inclined to enter into foreign-exchange transactions to hedge purchases of foreign securities, compared with previously. The narrow yield spreads have thus weakened the krone. Since the outbreak of the financial turmoil in the 2nd half of 2007, the krone rate has tended to mirror the development in the yield spread for actual monetary-policy operations and FX swaps, respectively, cf. Chart 7.

On the other hand, the money-market interest-rate spreads between Denmark and the euro area for uncollateralised lending, repo lending, and overnight interest-rate swaps have been higher than the implied interest-rate spread for FX swaps, by and large remaining at a level corresponding to the spread between Danmarks Nationalbank's lending rate and the ECB's minimum bid rate, cf. Chart 8.

The turbulence in the money markets is also reflected in the persistently high volatility of the spread between uncollateralised and collateralised money-market interest rates since the summer of 2007. After a considerable decrease from the turn of the year, the spread widened again during March and April, cf. Chart 9.

In ERM II the central rate for the Slovak koruna was revalued by 17.6472 per cent against the euro with effect from 29 May 2008. The fluctuation band is still +/- 15 per cent around the central rate. The conditions for the other ERM II currencies, including the Danish krone, are unchanged. The European Commission has proposed that Slovakia should join the euro area as from 1 January 2009. The proposal is expected to be adopted at the meeting of the Ecofin Council on 3 July.

Temporary secured lending facility at Danmarks Nationalbank
In the Danish money market, the impact of the international financial turmoil has almost entirely centred on the longer-term uncollateralised money-market interest rates. The very short-term money-market interest rates have followed Danmarks Nationalbank's interest rates very closely.^[6] There has been no need for extraordinary provision of liquidity to the money market by Danmarks Nationalbank as a consequence of the turmoil.

The turmoil has turned out to be persistent, however, and the banks have been reluctant to grant other banks uncollateralised loans at the longer maturities in the money market. In order to support the exchange of liquidity among Danish banks and mortgage-credit institutes, Danmarks Nationalbank in May opened a temporary 7-day secured lending facility that allows banks and mortgage-credit institutes to borrow against special loan bills issued by banks domiciled in the Kingdom of Denmark on standard terms and conditions set out by Danmarks Nationalbank, cf. Box 4. Danmarks Nationalbank accepts loan bills as eligible collateral from 23 May 2008 to 20 May 2009. This eligibility allows banks to include holdings of loan bills issued by other credit institutions in their liquidity pursuant to the Danish Financial Business Act.

Bank interest rates and credit
The banks' average interest rates in relation to the corporate sector rose by0.2 percent for deposits and 0.3 percent for lending from July 2007 to April 2008, cf. Chart 10. The rates of interest in relation to households have risen by 0.2 per cent. Some banks announced further general interest-rate increases of 0.25-0.5 per cent in April and May. The increasing interest rates for corporate lending should be viewed in the light of the high number of loans that are associated with uncollateralised money-market interest rates. In addition, the banks have raised their lending and deposit rates, citing higher financing costs in the money and capital markets in connection with the international financial turmoil. The development has also led to intensified competition for deposits.

Overall growth in lending by banks and mortgage-credit institutes remained high, at 12.3 per cent year-on-year at the end of April, cf. Chart 11. Growth in lending to households has been declining since 2006.

THE DANISH ECONOMY: REAL ECONOMY

Economic activity, private consumption and the housing market
Growth in the Danish economy declined to 1.8 per cent in 2007 after a strong increase in the preceding years. No official figures are available yet for the development in GDP into 2008, but on the basis of the available data releases, the slowdown is estimated to have continued in 2008. The Danish economy remains close to its capacity limit where labour and capital shortages limit the scope for further growth.

Viewed in isolation, the international financial turmoil and the resultant slowdown in global economic growth are estimated to curb growth in Denmark by around 0.5 percentage point annually in 2008 and 2009, cf. Box 5. Due to the high capacity utilisation under the current cyclical conditions, the actual effect may be somewhat smaller than the calculated effect.

THE REAL-ECONOMIC EFFECT OF THE SUBPRIME TURMOIL ON DENMARK	Box 5
The subprime turmoil has impacted on the Danish economy through several channels. Growth in the international economy has slowed down, and stock prices have fallen in many countries, including Denmark. This Box analyses the effect of the turmoil on the basis of Danmarks Nationalbank's macroeconometric model, MONA. Specifically, Danmarks Nationalbank's latest forecast in Monetary Review, 1st Quarter 2008, is compared with an alternative scenario adjusted for the estimated consequences of the turmoil for export-market growth, interest-rate levels and stock prices as from the 3rd quarter of 2007. The calculation is thus based on a drop in stock prices by approximately 20 per cent in the period under review as a result of the turmoil, and on a slight decrease in bond yields. Since the calculation of the forecast in Monetary Review, 1st Quarter 2008, stock prices have rebounded considerably, and the effect of the subprime turmoil on bond yields has been all but eliminated.
DERIVED EFFECTS OF THE SUBPRIME CRISIS ON DANISH GDPAND UNEMPLOYMENT	Chart 12
Note: Deviations from the forecast in Monetary Review, 1st Quarter 2008. The vertical, broken line represents the onset of the subprime crisis. Source: Own calculations on Danmarks Nationalbank's macroeconometric model, MONA.
All derived effects – except the slightly lower level of interest rates – point to a dampening of economic activity. The overall effect on GDP constitutes 1 per cent by end-2009, cf. Chart 12. This corresponds to a reduction in annual economic growth by approximately 0.5 percentage point in both 2008 and 2009. Unemployment increases by almost 25,000 persons over two years. The drop in stock prices undermines household wealth, which contributes to reducing private consumption and thus GDP, although the effect is relatively modest. This also applies to the weakening of export-market growth. The strongest effect stems from the strengthening of the effective krone rate by more than 2.5 per cent, notably due to the weaker dollar. The effects are calculated in relation to the empirical correlations in the Danish economy under normal cyclical conditions. The effect of dampened demand on economic activity may be considerably less pronounced in the current situation with high capacity utilisation. The estimated effects should therefore be regarded as on the high side.

The dampening of the housing market continued, and prices for single-family houses declined a little by 0.4 per cent year-on-year in the 1st quarter. Housing price inflation began to decrease in 2006 when the number of homes for sale rose significantly, cf. Chart 13, and the "for sale" period increased. The higher number of homes for sale reflects recent years' significant residential investments, among other factors. Another consequence of the slowdown is that potential home buyers show more restraint, while the high and stagnant prices have induced homeowners to put their homes on the market.

Overall household wealth has fallen since mid-2007, cf. Chart 14, primarily due to declining stock and housing prices. Nevertheless, total wealth has grown substantially during the sustained upswing, amounting to around kr. 1.3 million per household against just under kr. 0.9 million at end-2003. At the same time, the upswing has allowed the households to considerably expand private consumption without a drain on total wealth, cf. Box 6. Overall, the finances of Danish households are therefore still sound.

HOUSEHOLD INCOME, CONSUMPTION AND SAVINGS	Box 6
The households' current savings are the difference between total income after tax and consumption. In order to obtain a true and fair view of the allocation of household income on consumption and savings, the income expression must necessarily include all savings, whether they are the result of a decision by the individual household or of collective schemes in the labour market. Since the compilation of household disposable income in the national accounts does not include contributions to collective pension schemes, i.e. labour-market pensions and ATP (Labour Market Supplementary Pension Fund), such contributions must be added to the disposable income.1 Chart 15 shows recent years' development in private consumption in relation to household disposable income, as well as a broader expression of income in which collectively agreed pension contributions have been added to the disposable income. While the consumption ratio has risen during the economic upswing that began in 2003, consumption has not exceeded disposable income plus collective pension contributions. On the basis of the strong income growth in recent years, households have been able to significantly increase consumption without drawing on their wealth.
CONSUMPTION RATIO WITH AND WITHOUT COLLECTIVE PENSION CONTRIBUTIONS	Chart 15
Note: 4-quarter moving averages. Source: Statistics Denmark.

Higher employment and rising wages have contributed to increasing disposable real incomes for the households in recent years. In 2007, total employment rose by just over 50,000, and average real wages in the private sector grew by 2.0 per cent. Looking forward, unemployment is expected to rise, but the current high rates of wage increase will prevail for some time to come. In addition, income-tax cuts are envisaged in 2008 and 2009. Overall, the households' real disposable incomes are expected to grow by more than 2 per cent in both 2008 and 2009.

On the basis of the households' sound, albeit slightly declining, net worth and prospects of rising disposable real incomes as well as virtually unchanged housing prices in the near future, private consumption is expected to rise a little from the current high level.^[7]

Business investments reached a high level in 2007 and are not expected to contribute to higher demand in the next few years.

Foreign trade and balance of payments
The strong import growth continued into 2008, but at a more subdued pace, cf. Chart 16. Imports of goods to the corporate sector rose considerably, while imports for consumption were virtually unchanged after strong growth in recent years.

Despite the strong domestic demand, solid growth was also observed in exports of goods, and the balance of trade has fluctuated around a monthly surplus of just under kr. 2 billion since the spring of 2007.

Export growth in 2008 is primarily driven by an increase in manufactured exports as a result of sound export-market growth. The expected slowdown in these markets is reflected in declining growth in the export order books of industry.

Oil production in the North Sea is decreasing, but energy exports remain high in value terms due to the high oil prices. Rising oil prices benefit the balance of trade since Denmark is a net exporter of crude oil. As a result of a number of factors, however, oil-price fluctuations have only a minor effect on the current account of the balance of payments, cf. Box 7.

The current account showed a deficit of kr. 6.1 billion in the 1st quarter, i.e. kr. 2.4 billion less than the deficit in the 1st quarter of 2007. Over the last 12 months the current account shows a surplus of almost kr. 25 billion.

Labour market and wages
Unemployment has continued to fall in 2008. The number of unemployed people was 49,100 in April, corresponding to 1.8 per cent of the labour force.

The strong growth in output and employment in recent years has exerted massive pressure on the labour market and entailed a pronounced labour shortage. Confidence indicators show that there is hardly any labour shortage left in manufacturing, while it still prevails in the construction sector, cf. Chart 17. The public sector is experiencing considerable labour shortages in a number of professions.

The pressure on the labour market has contributed to high wage demands from the employee side in the spring collective bargaining for the public sector. Bargaining has been concluded for the central government, but is still going on for some employees in local and regional government. The general framework for the collective agreements concluded is around 13 per cent over three years, including the expected outcome of the regulation scheme that will ensure parallel wage development in the private and public sectors. However, several elements of the new collective agreements are kept out of the regulation scheme, which will boost wage growth in the public sector, all other things being equal, over the term of the collective agreement. The agreed wage increases are strongest in 2008, and the annual wage increases in the public sector are expected to reach 5-6 per cent towards the end of the year.

In the private sector, labour shortages have pushed up wage increases to a high level. In the 1st quarter, the overall rate of wage increase for the area covered by the Confederation of Danish Employers was 4.6 per cent year-on-year, cf. Chart 18. The pace of wage increases has thus reached a level that is unsustainable in the longer term.

For several years, the rate of wage increase has been higher in Denmark than abroad, the countries being weighted according to their importance to Denmark's foreign trade: 1 percentage point higher in the 1st quarter of 2008. Wage competitiveness is also squeezed by the strong depreciation of the dollar, which has brought the krone to the highest level for 25 years. The development in Denmark's wage competetiveness in a longer perspective is described in a separate article on p. 81.

Prices
In April, the Harmonised Index of Consumer Prices, HICP, rose by 3.4 per cent year-on-year. Price inflation has been rising since the 3rd quarter of 2007 and has now reached the highest level ever in the just over 11 years of the HICP series. The higher consumer price inflation is primarily driven by strong increases in energy and food prices. Price inflation for the other goods and services in HICP – core inflation – has been moderate at 1.5 per cent year-on-year in April.

The increases in energy and food prices are mirrored in wholesale commodity prices, including notably fuel and raw materials foragriculture. Wholesale prices have accelerated since September, and the year-on-year increase was 7.7 per cent in April, cf. Chart 19. On the other hand, moderate increases are still observed in the wholesale prices for many other goods that are not directly influenced by commodity prices. This applies to both means of production and non-food consumer goods.

Domestic market-determined inflation, IMI, is an indicator of the price pressures from payroll costs and profits. It has shown a declining trend since mid-2007. In the calculation of IMI, a number of elements are excluded from the consumer price index, e.g. food prices since they are affected by special factors such as harvest and weather. IMI thus fails to capture the latest increase in food prices, which has pushed consumer prices upwards overall.

Despite the significantly higher commodity prices, the increase in consumer prices for food is partly attributable to higher domestic payroll costs and profit margins, including for Danish farmers. If unprocessed foods (meat, fish, fruit and vegetables) only are excluded from consumer prices in the calculation of IMI,^[8] the result is a quite different pattern since October, cf. Chart 20. IMI including processed food rose to almost 3 per cent year-on-year from October to February, compared with approximately 1.3 per cent year-on-year for the conventional IMI in the same period.

Irrespective of the delineation of food, IMI declined in March and April. This is related to energy and import price inflation as the estimated indirect content of this inflation in consumer prices is eliminated from the calculation of IMI. Experience shows that such imported price increases are passed on to consumers with a certain lag. The imported price increases are initially borne by business enterprises by way of reduced profit margins and thus a lower IMI. The development in recent months thus indicates that consumer prices will rise further in step with the business enterprises' adjustment of their prices as a consequence of higher prices for energy and imported goods. Rising payroll costs for the business enterprises also contribute to higher prices.

Consumers have noticed the higher food and energy prices. According to Statistics Denmark's monthly survey, the share of consumers reporting that prices have risen has grown significantly since the late summer, cf. Chart 21. The share of consumers expecting price increases in the coming year rose in the 2nd half of 2007, and the higher level of expectations of price increases has continued into 2008.

Despite the slowdown in economic growth, the strong pressure on the Danish economy and especially the labour market will continue. This makes it imperative not to ignore the risk of an unsustainable course of prices and wages and rising inflation expectations. Against this background, it is important that fiscal policy in 2009 does not stimulate demand.