Recent Economic
and Monetary Trends

On 23 April, Greece applied to the euro area member states and the IMF for assistance within the framework of an agreed economic stabilisation programme. Initially the yield spreads continued to widen, and focus increasingly turned to other countries whose debts gave rise to concern, notably Portugal and Spain. Nervousness spread from the European to the global financial markets, reflected in falling risk appetite and surging volatility. When the EU on 9 May announced an ambitious financial stabilisation package, cf. Box 1, and the European Central Bank, ECB, announced extraordinary monetary-policy measures, including purchase of government bonds in the secondary market, the markets calmed down only temporarily.

As the growth outlook improved and risk appetite grew, the benchmark stock indices rose in the first months of the year, but the debt crisis in Greece and increased uncertainty about the extent of the budget problems led to falling global stock indices in May. The stabilisation package that was announced on 9 May only briefly halted the downward trend. The benchmark stock indices in the USA and Europe rose a little from end-May, but in early June they were approximately 3 per cent lower than at the turn of the year. 10-year government bond yields, which have fluctuated considerably, have fallen by approximately 0.5 per cent in the USA and approximately 0.4 per cent in the UK, to 3.4 and 3.6 per cent, respectively, in early June. German government bond yields have, on account of their status as a "safe haven" in Europe, fallen by approximately 0.7 per cent since the turn of the year, to 2.7 per cent in early June.

A rising yield spread in favour of the USA and uncertainty about the Greek economy, combined with concerns that the problems will spread to other euro area member states, have weakened the euro by approximately 15 per cent vis-à-vis the dollar from January to early June, cf. Chart 7. Following the euro area member states' and the IMF's agreement on a loan programme for Greece and also the announcement of the European stabilisation package on 9 May, the euro temporarily strengthened, but subsequently it has fallen to its lowest level against the dollar since the spring of 2006. Since the turn of the year, the euro has weakened by approximately 6 per cent vis-à-vis the pound sterling and the Swedish krona.

Lending surveys for the 1st quarter of 2010 from the Federal Reserve and the ECB indicate that the banks have all but stopped tightening their credit standards for corporate loans, especially to large corporations, while credit standards for loans to households are still being tightened. Credit conditions remain restrictive after two years' accumulated tightening that has not yet been reversed. Despite the economic rebound, no easing of credit policies has been announced. However, US data point to a tendency to ease credit policy through ordinary lending activities, although no active decision is made to do so. Hence the figures may indicate a more restrictive credit policy than is actually the case. The demand for loans from the corporate sector and the households continues to fall.

Due to the global economic upswing, among other factors, the IMF has lowered its estimate for the banks' write-downs in the period 2007-10 from approximately 2,800 billion dollars in October to 2,300 billion dollars in April. Two thirds of the losses are estimated already to have been realised, mostly in the USA. Assuming the expected economic development, both US and European banks can be expected still to have exposures that will give rise to considerable write-downs. US banks could face further write-downs since one in four US homeowners is technically insolvent. The increasing fiscal imbalances also pose a downside risk to financial stability.

In the USA, the authorities have become involved in the financial sector in response to the financial crisis – via the Federal Reserve's easing of monetary policy and via the Treasury's extraordinary injection of capital into troubled banks (TARP, Troubled Asset Relief Program). Unwinding of these measures is now well underway. The exit from TARP has been more rapid than expected, especially because of repayments from many banks and the Treasury's proceeds on the sale of bank securities. In April the banks had repaid 70 per cent of the total TARP funds received. Unwinding of government involvement in the mortgage finance enterprises Freddie Mac and Fannie Mae and the insurance company AIG is, however, still in the early stages.

On 16 April the IMF's Executive Board completed the second review under the stand-by arrangement with Iceland and approved the related loan disbursement. Prior to the approval, Iceland had confirmed its commitment to observing its obligations vis-à-vis holders of guaranteed deposits with the nationalised Icelandic banks and expeditiously completing the negotiations with the governments of the UK and the Netherlands in this respect. This paved the way for releasing the second instalment of the loans from the other Nordic countries.

Monetary policy
Monetary policy is strongly expansionary in most countries. In the USA, the euro area and the UK, policy interest rates remain record low at 0-0.25, 1.0 and 0.5 per cent, respectively. Due to extraordinarily ample liquidity, short-term money-market interest rates in the euro area are considerably lower than the ECB's key interest rate. With the prospects of a moderate economic upswing and dampened inflation, market participants and international organisations expect central banks in most OECD countries to keep their accommodative monetary policies unchanged throughout 2010.

In addition to historically low policy interest rates, many central banks have introduced quantitative easing by supplying ample liquidity and purchasing securities. As conditions in the financial markets have normalised, certain measures have been phased out – either directly by the central banks or indirectly by way of reduced demand. Renewed financial turbulence in the spring in response to euro area budget problems has, however, led to the reintroduction of some of these measures.

The Federal Reserve ceased to purchase mortgage-backed securities at end-March. This had practically no market effect. Moreover, the Federal Reserve has discontinued most of its extraordinary liquidity facilities and plans to terminate the last one at end-June.

The ECB has mainly operated with extraordinary liquidity allotments during the crisis and had very gradually begun to phase out these measures. To stem the rising tide of uncertainty in the financial markets concerning the debt problems in several euro area member states, the ECB on 10 May decided to reintroduce longer-term refinancing operations (3 and 6 months) and full liquidity allotment in the tenders on 12 May, 26 May and 30 June. In addition, the Federal Reserve, at the request of the ECB (and the central banks of Canada, England, Switzerland and Japan), has reactivated its temporary swap facilities in order to ensure ample dollar liquidity. So far these facilities, which will expire in January 2011, have been used only to a limited extent. As a new, extraordinary measure, the Eurosystem has also begun to purchase government and corporate bonds in the secondary market to boost the depth and liquidity of these market segments. The ECB will conduct special liquidity-absorbing operations to neutralise the overall monetary-policy impact.

Fiscal policy
Loss of tax revenue and increased government spending in the wake of the financial crisis, combined with massive fiscal stimulation, have led to increasing budget deficits and government debt in OECD countries. As a result, almost simultaneous fiscal consolidation is called for across the OECD countries, although the need varies somewhat from country to country, cf. Chart 8. The long-term consolidation requirement is most acute in countries such as Greece, the USA, Ireland and the UK. However, due to its status as a reserve-currency country and a "safe haven" for international investors, the USA currently has greater fiscal scope than the other countries.

The Stability and Growth Pact, which is at the core of the EU's fiscal surveillance of the member states, has really come into play. In 2009, the vast majority of member states exceeded the Pact's limit for budget deficits, i.e. 3 per cent of GDP. Consequently, the Commission has given or will give these member states notice to reduce their deficits to below 3 per cent of GDP within a few years.

The majority of EU member states submitted convergence and stability programmes in the spring. Most of them envisage fiscal consolidation from 2011 onwards, but already from 2010 in the most severely affected member states, where the budget crisis has evolved into a confidence crisis in the financial markets. A case in point is Greece, but also Portugal and Spain have brought forward and stepped up their planned fiscal consolidation.

For the EU overall, the average budget deficit is expected to decline from 7.2 per cent of GDP in 2010 to 6.5 per cent in 2011, while debt is expected to mount further, from 75 to 84 per cent of GDP. In Denmark, prior to the conclusion of the recent political agreement to consolidate the Danish economy, the Ministry of Finance expected the budget deficit to fall from 5.1 per cent of GDP in 2010 to 4.4 per cent in 2011, while debt was expected to increase from 42 to 45 per cent of GDP.

It is difficult to assess the extent to which tightening of fiscal policy will impede the economic upswing. Several studies indicate that tightening of fiscal policy may be less contractive, and in some cases even expansionary, if the fiscal starting point is very weak, cf. Box 2. The reason is that interest rates may drop and confidence in the future rise when a country that has been on an unsustainable debt path gets its public finances back under control.

In any case, the debt problems in many countries are already so extensive that there is no other option but to introduce sizable fiscal tightening measures. This has already been done in e.g. Greece, Ireland, Portugal, Spain and Latvia, but also countries such as the UK and the USA have so large budget deficits that austerity measures must be implemented soon in order to rein in their debts. Government budget deficits of the magnitude seen in the wake of the financial crisis are only possible for a very brief period if fiscal sustainability is not to be jeopardised.

Fiscal consolidation will thus be on the agenda across the OECD countries in the coming years. The international economic organisations have emphasised that consolidation is most likely to have positive confidence effects, and thus lead to falling long-term market interest rates, if it is part of a credible medium-term plan that also comprises relevant structural reforms to increase the long-term output potential.

In a situation where international investors are increasingly focusing on government budget problems, it is important that Denmark indicates willingness and ability to implement consolidation measures that will eliminate the government budget deficit within a few years. If not, confidence in the Danish economy and the fixed-exchange-rate policy might be jeopardised.

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

Danmarks Nationalbank has reduced the rate of interest on certificates of deposit and the current-account rate on several occasions, namely on 26 March, 20 May and 27 May, both rates being reduced by 0.10 percentage point on all three occasions. The rate of interest on certificates of deposit is now 0.50 per cent, while the current-account rate is 0.40 per cent. The lending and discount rates have been kept unchanged at 1.05 per cent and 0.75 per cent, respectively.

The interest-rate cuts took place against the background of purchases of foreign exchange in the market. From March up to and including May, Danmarks Nationalbank purchased foreign exchange for a total of kr. 42 billion in connection with interventions in the market. At end-May the foreign-exchange reserve was kr. 441 billion, having increased by kr. 24 billion since the beginning of March.

Spreads between money-market interest rates in kroner and euro have narrowed in recent months, cf. Chart 9. Due to the recent turbulence, the implied interest-rate spread for FX swaps between kroner and euro has narrowed more than the other spreads.¹ Normally a premium applies when trading euro for kroner forward, but at the end of May this premium was around zero. This should be viewed in the light of falling demand for hedging in euro. From the 2nd half of 2007 until October 2008, the implied interest-rate spread was negative at times, reflecting shortage of euro liquidity.

Although interest-rate spreads between both collateralised loans (interest-rate swaps) and uncollateralised loans in Denmark and the euro area have narrowed, they remain wider than the corresponding monetary-policy spread, cf. Chart 9. The reason is that since the autumn of 2008 the ECB has provided substantial liquidity to euro area banks in response to the tight liquidity situation that arose in connection with the financial turmoil. Short-term money-market interest rates in the euro area are therefore considerably lower than the ECB's rate of interest on its main refinancing operations. As the liquidity situation normalises, this may lead to rising money-market interest rates in the euro area and narrowing of the spread between monetary-policy interest rates in Denmark and the euro area.

On account of the turbulence in the financial markets, the ECB has temporarily put its normalisation of the liquidity situation in the euro area on hold. Consequently, a 6-month liquidity operation was conducted in May, although the 6-month operation in March was to have been the last one. Furthermore, the ECB decided to reintroduce full allotment at a fixed rate of interest in the 3-month operations in May and June. In April the ECB had held one tender with allotment of 3-month liquidity at a variable rate as part of its effort to normalise the liquidity situation.

The changes in monetary-policy interest rates have widened the spread between the lending rate and the rate of interest on certificates of deposit to 0.55 percentage point. This margin gives banks and mortgage-credit institutes an incentive to settle liquidity differences among themselves in the money market rather than resorting to Danmarks Nationalbank's facilities.

The interest-rate margin²has contributed to reducing gross accumulation on Danmarks Nationalbank's balance sheet, and monetary-policy lending has more or less been reduced to zero. Since 8 June 2009, when the interest-rate margin was introduced, the banks and mortgage-credit institutes have reduced their monetary-policy loans from Danmarks Nationalbank by kr. 170 billion, which is far more than warranted by the kr. 81 billion increase in the net position in connection with capital inflows. This is reflected in a kr. 89 billion reduction in the institutions' holding of certificates of deposit and current-account deposits, cf. Chart 10.

On 8 April Danmarks Nationalbank announced that the temporary credit facilities for banks and mortgage-credit institutes at Danmarks Nationalbank – the option to borrow on the basis of excess capital adequacy and the expansion of the list of assets eligible as collateral – will be extended until 26 February 2011.

Danmarks Nationalbank regularly assesses the collateral rules applying to credit facilities at Danmarks Nationalbank. The framework for credit operations and the temporary facilities during the financial crisis are elaborated on in the article on p.117.

Money and capital market developments
A new scheme (Bank Rescue Package 3) for management of ailing banks will be introduced with effect from 1 October 2010, when the general government guarantee expires. The Financial Stability Company will still be able to acquire ailing banks with a view to winding them up in a controlled manner. The scheme does not include any government guarantee as it is based on writing down equity, subordinated capital and creditor claims corresponding to the value of the assets, as well as sector contributions via the Guarantee Fund for Depositors and Investors. Under the Act, the individual bank must be able to provide the necessary overviews of accounts, etc. within 24 hours. This means that a crisis situation can rapidly be addressed. Depositors with net deposits of up to 100,000 euro, approximately kr. 750,000, will not initially notice any practical changes in their day-to-day banking activities. The Dankort and direct debit services will remain in operation. The individual bank has no obligation to apply this model in the event of problems, but at the first general meeting after the commencement of the Act it must decide whether it wishes to announce whether or not it will use the model in the event of a crisis.

Effective 1 October 2010, the Guarantee Fund will cover depositors with ordinary deposits of up to 100,000 euro net. Special deposits, including pension schemes, will still be fully covered. The deposit guarantee will eliminate uncertainty for the vast majority of depositors. Depositors with larger deposits can be expected to seriously assess their banks so that banks deemed to be risky will find it more difficult to attract deposits.

The Credit Package, also known as Bank Rescue Package 2, gives banks and mortgage-credit institutes the option, under certain conditions, to acquire an individual government guarantee covering their own fixed-term bonds against payment of commission. This will facilitate the transition to normal market conditions for unsecured creditors. The status as at 20 May 2010 was that agreements had been concluded with 31 institutions that had received guarantee commitments totalling kr. 260 billion. 25 institutions had issued for a total of kr. 105 billion under the scheme. The guarantee scheme comprises bonds issued until 31 December 2010.

The Danish government intends to increase the commission payable by banks and mortgage-credit institutes for issuing bonds with a government guarantee. This is a response to an initiative from the Commission, which believes that the financial markets have stabilised to an extent that makes it appropriate to give participating institutions a stronger incentive to deselect government guarantees. The increase in commission will depend on the credit rating of the individual institution. Those with the highest ratings will have to pay an extra 0.2 percentage point for new guarantees, while those with the lowest ratings will have to pay an extra 0.4 percentage point compared with today, bringing the maximum commission payable to 1.35 per cent. The increase is expected to take effect in July 2010. Banks that are members of the Danish Contingency Association will still receive a discount on the part of the guarantee that relates to non-subordinated unsecured debt until the expiry of the general government guarantee on 30 September 2010. The discount is calculated on the basis of the institution's contribution to the Danish Contingency Association.

The Commission has tabled a number of proposals for amendment of the existing rules on banks' liquidity and capital adequacy with a view to boosting the financial sector's resilience to future financial crises. The proposed liquidity regulation distinguishes between various asset types, depending on their liquidity. Mortgage-credit bonds are assessed to be less liquid than government bonds, which may weaken the Danish mortgage-credit market. In a joint consultation response with the Danish Financial Supervisory Authority, Danmarks Nationalbank has pointed out that Danish mortgage-credit bonds should be regarded as fully liquid assets as they are to a large extent comparable to government bonds.³

Another proposal calls for more stable funding for financial institutions. This means that mortgage-credit bonds with a remaining maturity of less than one year are not regarded as stable funding. At the same time, loans with a maturity of more than one year are subject to a stable funding requirement. This could put a stop to adjustable-rate mortgages in their current form.

The banks' and mortgage-credit institutes' interest rates
Yields on Danish mortgage-credit bonds have continued to fall in recent months. In the first week of June, the average yield on a 1-year non-callable fixed-rate bond ("fixed bullet") for financing adjustable-rate mortgages was 1.06 per cent, while the long-term yield was 4.36 per cent. Both levels are very low, cf. Chart 11.

Auctions for fixed bullets were held in the spring. This reduces the refinancing burden at the turn of the year, so that a more suitable and even distribution profile is achieved for refinancing of adjustable-rate mortgages. Sales in the March auctions totalled around kr. 50 billion. Adjustable-rate mortgages now account for two thirds of total Danish mortgage lending, and three quarters of these loans have a remaining term to maturity of less than one year.

Following Danmarks Nationalbank's reductions of its monetary-policy interest rates, the banks have also cut their interest rates, but there has not been a one-to-one relationship in the period under review, cf. Chart 12. The banks only to a limited extent followed suit when Danmarks Nationalbank reduced its interest rates in the months following the eruption of the financial crisis in the autumn of 2008. The turmoil rapidly evolved from a liquidity crisis to a credit crisis with a greater risk of losses. The spreads between Danmarks Nationalbank's monetary-policy interest rates and the banks' lending rates thus widened and have not subsequently narrowed, cf. Chart 13.

The banks' interest-rate margins have increased since the autumn of 2008, which should be viewed in the light of the economic recession. Historically, interest-rate margins have widened in recessions, e.g. in 1993-94, cf. Chart 14. The most recent widening masks an increase in the interest-rate margin for the corporate sector by more than 1 percentage point since the summer of 2008, while the interest-rate margin for households has fallen back to the 2007 level. An underlying factor is that the banks' write-downs relate primarily to corporate customers.

Credit developments
Bank lending has ceased to fall. In fact, growth in lending to the corporate sector has been marginally positive since the turn of the year, while lending to households has been more or less flat, cf. Chart 15. At the same time, the mortgage-credit institutes continue to lend more to the corporate sector. Total lending to the corporate sector has risen since the turn of the year, while it has been virtually unchanged for households.

According to Danmarks Nationalbank's lending survey, the banks and mortgage-credit institutes have maintained the tighter credit policies introduced in the 4th quarter of 2008 and the 1st quarter of 2009. Hence, according to the credit institutions there has not been any easing of credit policies in the past year.

The lending survey shows that the banks and mortgage-credit institutes overall recorded slightly higher demand for loans from both the corporate sector and the households in the 1st quarter of 2010 than in the 4th quarter of 2009. Moreover, they generally expect the demand for loans from both sectors to increase further in the 2nd quarter of 2010. This supports the view that the economy is rebounding.

The Danish economy: real economy

Economic activity
Growth in the Danish economy continued in the 1st quarter of 2010, when seasonally adjusted GDP in volume terms was 0.6 per cent higher than in the preceding quarter. Growth has thus been positive for three quarters running, but this follows a fall in GDP by just over 7 per cent, cf. Chart 16. Like output, private consumption has been rising since mid-2009 after having declined sharply in the preceding period. Although the economy is now rebounding, both activity and private consumption remain far below the pre-crisis levels. It will probably take until 2013 for output to return to the level seen at the eruption of the crisis. In late May 2010 political agreement was reached on a consolidation plan for the Danish economy. The agreement is expected to have only limited impact on economic activity in 2011 and 2012, cf. Box 3.

Growth in private consumption is supported by a considerable increase in disposable incomes, following the income-tax cuts that took effect in January 2010. In addition, low interest rates boost consumption opportunities for households with variable-rate loans, while also providing an incentive to consume rather than save. Furthermore, rising stock indices combined with stabilisation of house prices have contributed to increasing household wealth after the strong decline in 2008 and 2009.

The moderate upswing in the economy is reflected in confidence indicators. Expectations in both the service sectors and the industrial sector have been rising over the past year and confidence indicators are now positive for both sectors, cf. Chart 17. The construction sector, which is severely hit by the crisis, is still characterised by widespread pessimism, although this indicator is also showing signs of picking up. In spite of these positive signals, the number of bankruptcies remains high.

Industrial production seems to have stabilised after having declined sharply in 2008 and the 1st half of 2009. Nevertheless, the level remains more than 20 per cent below the peak in early 2008, and in spite of rising industrial expectations output cannot be expected to return to the pre-crisis level in the near future. In addition, companies may to some extent have seen the downturn as an opportunity to adjust output and relocate parts of their production to low-cost countries.

Retail sales fell by 4.2 per cent from March to April after a strong increase in March. This unusual pattern of a surge followed by an abrupt fall is presumably to some extent attributable to the fact that Wednesday before Easter, when retail sales are high, was on the last day of March, so that all Danish public holidays around Easter were in April. This factor can be eliminated by looking at March and April as a whole. Total retail sales in March-April were 0.1 per cent higher than in January-February. Dankort transactions point to retail sales remaining flat in May. Consumer confidence has picked up notably over the last year and is now above its average since 1987. Consumers expect the Danish economy to be better one year ahead than it is now, but at the same time they believe that the economy is worse today than it was one year ago.

Sales of passenger cars were higher in April 2010 than in the same month of 2009. Sales to the corporate sector have risen more than sales to households, which may reflect the increasing popularity of leasing to households. Overall the confidence indicators point to favourable conditions for the households. Since the consumption-to-income ratio resulting from rising disposable incomes is also relatively low when viewed in a longer-term perspective, there are signs that private consumption will develop favourably in the coming quarters.

The housing market
According to seasonally adjusted data from the Association of Danish Mortgage Banks, prices for single-family and terraced houses continued to rise in the 1st quarter of 2010, cf. Chart 18. Moreover, turnover in the housing market has increased since the trough in the 2nd quarter of 2009. It thus looks as if the housing market has stabilised following a strong adjustment of the price level. Seasonally adjusted prices are now on average just over 14 per cent lower than at the peak in the 2nd quarter of 2007, while the negative tide has turned. The rebound is most pronounced in the Copenhagen area, which was also where the largest price drops were seen previously. However, the supply of homes on the market remains high and the number of sales is below the average since 2000.

House prices are supported by low interest rates and rising disposable incomes in the households and remain high relative to the historical trend. The number of enforced sales has increased since 2007, but remains far below the level seen in previous downturns. A major difference compared with previously is that a larger share of homes are now financed via variable-rate mortgages, which are currently very cheap. Consequently, a further increase in the number of enforced sales cannot be ruled out when interest rates begin to rise.

Foreign trade and balance of payments
Exports of goods rose by 10.1 per cent in March after having been virtually flat since the summer of 2009. This could imply that the rebound in the global economy is beginning to be reflected in Danish exports. All the same, exports remain well below the level seen before the financial crisis, and it is too early to draw any firm conclusions on the basis of data from just one month. However, the assumption that exports of goods are beginning to pick up is supported by a more favourable view of export order books in the industrial sector. Imports of goods have been rising since late 2009, but have fallen more than exports over the last couple of years. Hence, the balance of goods still shows a large surplus.

In the last 12 months, the current account has shown a surplus totalling kr. 71.1 billion, compared with a surplus of kr. 43.3 billion in the preceding 12 months. Particularly the surplus on trade in goods has increased relative to the year before, but investment income has also increased. Conversely, the surplus on trade in services has diminished, reflecting that the fall in global trade has had a severe impact on earnings from sea freight. The current-account surplus is expected to decline as domestic demand increases. In the longer term, falling income from energy exports will also reduce the current-account surplus.

Labour market
When adjusted for seasonal fluctuations, registered unemployment has been more or less flat over the past six months. In April, seasonally adjusted unemployment was 114,300, corresponding to 4.1 per cent of the labour force. According to the labour-force survey, EU-harmonised unemployment, which also includes job seekers not registered as unemployed, was 7.5 per cent in the 1st quarter of 2010 (own seasonal adjustment).

It is unusual for unemployment to stabilise so early during a downturn. The trend in unemployment in recent months is, however, not necessarily an indication that the labour market is rebounding. Box 4 analyses a number of potential factors underlying the moderate increase in registered unemployment. For example, the labour force has shrunk by around 100,000.

The decline in employment is purely attributable to the private sector, whereas public-sector employment overall has risen by 16,000 since the 1st quarter of 2008. The number of new jobs advertised has stabilised at around a trough of 14,000 per month, seasonally adjusted. This figure was more than twice as high towards the end of the most recent boom.

Unemployment has fallen by less than output, meaning that productivity growth has been weak until recently, cf. Chart 19. A characteristic of the Danish labour market is that it is relatively easy for companies to adjust the number of employees to current requirements. Hence, employment protection legislation cannot explain why companies seem to be hesitant to adapt to lower output. One explanation could be that they expect to increase production again before too long.

The newly concluded collective agreements introduce severance pay to employees that have been with a company for at least three years. This will make it more expensive to adjust the number of employees in future downturns.

Wages and prices
Wage inflation in the private sector has moderated substantially as labour market pressures have eased. For members of the Confederation of Danish Employers (DA), annual wage inflation was 2.6 per cent on average in the 1st quarter of 2010, cf. Chart 20. In comparison, wage inflation peaked at 4.9 per cent in the 2nd quarter of 2008. The lowest wage increases were seen in the building and construction sector, which has been particularly severely affected by the crisis.

Wages in the public sector have risen substantially more than wages in the private sector in recent quarters. This trend will presumably reverse, as a special regulatory arrangement ensures that wage inflation in the public sector mirrors the private labour market with a certain lag. Wage inflation in the private labour market is now considerably lower than expected when the collective agreements for the public sector were concluded. This will be reflected in a very weak trend in public-sector wages in the coming quarters.

Despite the dampening trend, wage inflation in the highly competitive industrial sector remains higher than in Denmark's major trading partner countries, as has been the case for quite a few years. Combined with weak productivity development, this has for some time eroded the sector's international competitiveness.

Two-year collective agreements have been concluded for large parts of the private labour market. Wages in the minimum-wage system, to which most of the agreements pertain, must subsequently be negotiated at enterprise level. Therefore, actual wage increases cannot be predicted on the basis of the agreements alone, but judging from the agreements concluded in the normal-wage system, where wage increases are laid down in central agreements, modest wage increases are scheduled for the remainder of the collective agreement period. The moderate wage increases reflect the competitive situation, but as foreign wage increases are also declining strongly, competitiveness is expected to deteriorate further.

Consumer prices measured by the HICP were 2.4 per cent higher in April compared to the same month of 2009, cf. Chart 21. So, despite the weak domestic capacity pressure, the rate of inflation has risen since mid-2009, when it bottomed out at 0.5 per cent. The higher taxes on tobacco and other goods that took effect at New Year are assessed to have increased inflation by approximately 0.5 percentage points. HICP at constant tax rates, HICP-CT, is thus only 1.8 per cent higher than in the same month of 2009. Recently, rising energy prices have added to inflation. Both the higher taxes and the higher energy prices will, however, have only a temporary impact on inflation.

Unlike consumer price inflation, core inflation, which excludes changes in the prices of energy and food, has declined since mid-2009, to stand at 1.4 per cent in April. Since core inflation excludes the categories of goods that are traditionally most volatile in price, it can be seen as an expression of underlying inflation. Low core inflation thus indicates that the increase in consumer price inflation is a temporary phenomenon.

Economic policy
Following a sharp downturn in the wake of the international crisis, both the global and the Danish economy are now picking up. The financial turbulence in recent months and the prospects of substantial fiscal tightening do, however, pose downside risks to the budding upswing in Europe so it cannot be ruled out that growth in Denmark's export markets will be weak in the next few years. Nevertheless, trends in overall demand are assessed to be sufficiently strong to ensure a continued upswing in the Danish economy, although it will probably take until some time in 2013 for activity to return to the pre-crisis level.

Current economic policy is strongly expansionary. Policy interest rates are historically low, and the market expects them to remain so for a while. In addition, fiscal policy was eased considerably in 2009 and 2010. This was achieved by bringing forward public-sector investments and by phasing in the tax reform so that the income-tax cuts primarily take effect this year, while financing is phased in gradually. Moreover, public consumption is substantially higher than originally planned.

In this way both monetary and fiscal policies help to mitigate the impact of the economic downturn. Statistics from recent months indicate that unemployment will not rise as much as previously predicted before the labour market rebounds in earnest.

Denmark's government deficit for 2010 is expected to be in the range of kr. 100 billion, corresponding to around 5 per cent of GDP. This means that fiscal consolidation is necessary, not only in order to comply with the formal requirements of the Stability and Growth Pact, but also to ensure continued international confidence in the Danish economy. The financial market turbulence in the spring emphasised that countries with weak public finances risk being burdened with high interest rates on their government debt. Credible economic policy is a safeguard against pressure on the krone in periods of financial turbulence. Confidence is best ensured by initiating the consolidation process before the government debt has become too large. Furthermore, the fiscal tightening measures required will increase, the further a country has travelled along the path of deficit and debt.

Against this background it is positive that political agreement has been reached to consolidate public finances by a total of kr. 24 billion over the period from 2011 to 2013 inclusive. It is also positive that the agreement contains elements that can be expected to increase labour supply in the longer term. The upward trends in private domestic demand and exports mean that gradual consolidation of public finances from 2011 onwards will not stifle the budding upswing, cf. the calculations in Box 3 above.

A key element of the recent political agreement to consolidate the Danish economy is that growth in public consumption must be significantly more subdued than previously. Recent years' repeated over-expenditure relative to the growth framework for public consumption shows that it is a considerable challenge to tighten expenditure as planned. The consolidation plan includes certain adjustments to the framework for agreements on local-government finances, which will give the municipalities a greater incentive to observe the limits agreed with the central government. If, in spite of these measures, growth in public consumption is not kept within the agreed limits, new economic policy initiatives will be required in order to ensure the necessary consolidation of government budgets.