Persistently high inflationary pressures call for tight economic policy

Since early 2022, Danish economic growth has been subdued, thereby easing some of the pressure on the economy. The slowdown comes in the wake of eighteen months of boom in Denmark and abroad and three years of pandemic and war in Europe.

Subdued growth is easing capacity pressures in the Danish economy

Inflation has been easing considerably since late 2022, driven, in part, by lower energy prices. Underlying inflationary pressures and core inflation, which excludes energy and unprocessed food, are also coming down, but remain high.

High inflation has weakened household purchasing power and led to severe monetary tightening both in Denmark and abroad. Since early 2022, growth in large segments of the Danish economy, for instance domestic demand, has been subdued, with value creation below its potential.

So far, exports have been keeping aggregate demand afloat, and the gross domestic product, GDP, has been expanding, driven by a surge in the production of pharmaceutical products abroad under Danish ownership, see chart 1 and a detailed description in box 2. Production abroad under Danish ownership does not significantly impact Danish economic pressures in the short term because many of the jobs associated with such production are located abroad. So, overall, capacity pressures in the Danish economy are estimated to have eased.

Despite the economic slowdown, employment is still growing, unemployment is low and labour market pressures are strong. The same trend applies abroad, where labour markets have also been quite resilient to the slowdown in growth. In Denmark, last year’s strong labour market pressures and higher inflation were reflected in considerably higher-than-usual wage growth in the spring collective agreements, and this trend is also seen abroad.

In the coming year, growth is still expected to be below its potential, while the interest rate hikes of recent years work their way through the Danish and international economy. Subsequently, growth is likely to be more in line with its potential. The slowdown in growth is expected to cause employment to fall by 40,000 from the end of 2023 towards the end of 2025. Higher wage growth is assumed to increase inflationary pressures from domestic sources, keeping core inflation about 4per cent in the coming year.

With the slowdown in growth, capacity pressures will ease further over the coming year, and the Danish economy is expected to approach a neutral cyclical position during 2024, although with continued labour market pressures. There are no prospects of recession in the Danish economy. However, this expectation is based on the forecasts of a number of international organisations, assuming that inflation will be brought down without the current slowdown in growth sending the global economy into recession.

If production abroad is excluded, as described above, the slowdown in demand seen since late 2021 has been stronger in Denmark than in the euro area. As a result, capacity pressures in the Danish economy, which were considerably stronger than in the euro area a year or so ago, are now in line with those of the euro area. For instance, survey-based assessments of capacity utilisation in the manufacturing industry and shortages of labour and demand no longer indicate that capacity pressures in Denmark are stronger than in the euro area. Although capacity pressures in Denmark have been stronger than in the euro area, this has not translated into higher wage and price growth than in the euro area, and, based on the collective agreements concluded, overall wage growth is expected to be in line with the euro area throughout the projection period. However, throughout the projection period, Danish core inflation is projected to be slightly higher than most forecasters expect for the euro area.

Fiscal policy should continue to contribute to tight economic policy to dampen capacity pressures and inflation

Core inflation in Denmark and in the euro area is still high. So, overall, fiscal and monetary policy in Denmark still needs to help alleviate capacity pressures and underlying inflationary pressures. Both fiscal and monetary policy has been tightened in Denmark in recent years.

Danmarks Nationalbank has been raising interest rates considerably since summer 2022 in response to the monetary policy tightening by the European Central Bank, ECB, in the euro area to bring down inflation. The Danish fixed exchange rate policy means that Danmarks Nationalbank’s monetary policy instruments are reserved for ensuring a fixed exchange rate against the euro. Therefore, fiscal policy must ensure stable economic developments in Denmark. When capacity and inflationary pressures in Denmark and the euro area are uniform, Danish monetary policy will usually be broadly aligned with inflationary pressures. Conversely, if capacity and inflationary pressures are not uniform across Denmark and the euro area, fiscal policy will be used to address this issue.¹

Overall, both capacity pressures and inflation in Denmark are in line with the euro area, and Danish wage growth is expected to be on a par with the euro area throughout the projection period. There are no indications that the risk of an independent Danish wage-price spiral has risen in the past six months, and inflation expectations are well anchored. So, basically, the monetary policy that will slow economic activity sufficiently to bring down inflation in the euro area will also be sufficient to bring down inflation in Denmark with the currently planned fiscal policy.

Therefore, fiscal policy should continue to contribute to a tight economic policy, as envisaged by the current Finance Bill, so as not to counteract the interest rates hikes implemented in the euro area to bring down inflation. Accordingly, any measures in the Finance Act that increase capacity pressures must, at least, be matched by measures to ease capacity pressures correspondingly.

Inflation has cooled considerably across most of the world since late 2022, primarily because energy prices (especially electricity and gas prices) have fallen from their exceptional highs, see chart 2. In Denmark, inflation dropped from more than 10 per cent in October 2022 to 2.3 per cent in August, and consumer energy prices are now making a negative contribution to inflation. Although consumer energy prices have declined, they are still about 25 per cent higher than in the 1st half of 2021, before energy prices skyrocketed.

Underlying inflationary pressures are still high

Core inflation, which excludes consumer prices of energy and unprocessed food, remains high both in Denmark and the euro area, see chart 3. One reason is a lagged effect from higher energy prices in the production of other goods and services, the so-called indirect effects. Since early 2023, core inflation has been declining, partly in response to waning indirect effects. In Denmark, indirect effects contributed 3-4 percentage points to core inflation in late 2022, but in the 2nd quarter of 2023, this contribution decreased to between 1 and 2.5 percentage points.²

Core inflation in the USA is lower than in Denmark and the euro area, and is also largely driven by rent consumer price increases. Rents have increased more in the USA than in Denmark and the euro area and their weight in the consumer price index is higher. Calculated using the corresponding HICP measure, US core inflation is just under 2 per cent.

To assess current inflationary pressures, it is necessary to look at the momentum of consumer price changes rather than at the annual rate of increase. Momentum can be illustrated, for example, using instantaneous inflation, which emphasises developments in recent months, see. box 1. Using this measure, Denmark’s core inflation momentum weakened from about 6 per cent around the turn of the year to about 2.5 per cent in August. Momentum has slowed correspondingly in the USA and the euro area. Although core inflation momentum has decelerated, it is still high, indicating that underlying inflationary pressures remain high.

Since early 2023, inflationary pressures have been shifting from energy and other imported goods, determined largely by global markets, to domestic factors driven by wage growth. In Denmark, this shift is illustrated, for instance, by Danmarks Nationalbank’s measure of imported consumer price inflation, which has been declining slightly following a rise of more than 20 per cent in 2021 and 2022, see chart 4. Since late 2022, domestic market-determined inflation, IMI, which excludes factors such as direct and indirect price increases for energy and imported goods and services, increased sharply after having fallen in 2021 and the beginning of 2022. The recent increase is driven, in part, by a pick-up in price inflation of a number of services that are typically heavily dependent on wage developments.

Wage growth has started to pick up following the spring collective agreements

Danish wage growth accelerated sharply in the 2nd quarter following the spring collective agreements, but it remains lower than in the euro area. Wages are expected to grow further, catching up with the euro area during the autumn.

Admittedly, manufacturing wage growth, at 3.4 per cent in the 2nd quarter, was in line with wage growth in 2022, see chart 5. However, the 2nd quarter figures mask the abolition of the adjustment of the flexible spending supplement from the latest collective agreement period, which contributed 0.7 percentage points to wage growth, while the increase in company pension contributions only takes effect from the 3rd quarter of 2023. This means that basic pay will rise considerably relative to 2022. Until early 2023, wage growth in Denmark was relatively moderate considering the cyclical position of the economy.

Manufacturing wage growth is currently lower in Denmark than abroad. In the USA, wages already started growing at a faster pace in 2021 as labour market pressures mounted, with many frequent job changes and many people leaving the labour market.³ In the euro area, wage growth has also been accelerating since the 2nd half of 2022 as labour market pressures have intensified and households have been trying to recover some of their lost purchasing power following the sharp rise in consumer price inflation. The pick-up in wage growth has been driven partly by minimum wages, which have been raised in a number of European countries.⁴ This may have contributed to stronger wage growth in the euro area than in Denmark.

However, Danish wage growth is expected to catch up with wage growth abroad relatively quickly as local wage negotiations are completed and other parts of the collective agreements take effect later this year. Already from the 3rd quarter, an increase in company pension contributions is expected to boost wage growth in Denmark by up to 2 percentage points, which could be topped by a further rise in basic pay at the completion of the remaining local wage negotiations. Therefore, it is assessed that the commencement date of the new collective agreements is the primary reason why wage growth in Denmark is lower than abroad.

Based on the spring collective agreements, manufacturing wage growth in Denmark is expected to be about 5 per cent per year in the coming collective agreement period, lasting until spring 2025, see chart 6. So, Danish wage growth is expected to be largely in line with the euro area, where the European Central Bank, ECB, expects that wage growth will pick up in 2023, to 5.3 per cent, before slowing to 4.3 per cent in 2024 and 3.8 per cent in 2025 as labour market pressures ease.⁵ Conversely, the US Congressional Budget Office expects wage growth in the USA to gradually slow to 4.9 per cent in 2023, 4.4 per cent in 2024 and 3.7 per cent in 2025.

Wage growth in Denmark is expected to fall to 3.9 per cent in 2025 as labour market pressures ease, inflation comes down and wage growth also slows in the export markets in which Danish manufacturing companies compete.

Higher wage growth is expected to keep inflation high over the projection period

Inflation is expected to decline a little further during the rest of 2023 before picking up again in 2024, see chart 7. This masks a negative energy price contribution to inflation until early 2024, while underlying inflationary pressures are likely to remain high.

Based on futures prices of electricity, gas and oil, i.e. the prices of forward energy contracts, consumer prices of energy are assumed to remain around the current level for the rest of the year, which is in line with early 2022. Therefore, consumer energy prices are expected to be below their very high 2022 levels, thereby contributing negatively to inflation. However, inflation is expected to pick up again from early 2024 as the base effects of the high 2022 levels are excluded from the annual rate of increase of inflation, and base effects of the temporary reduction of electricity tax boosts inflation in the 1st half of 2024.

Core inflation is likely to remain high throughout the projection period, although trending downwards. Large segments of the private sector saw weak growth in earnings during the period of high inflation, although earnings were stronger in some of the industries in which prices reflect global conditions.⁶ So, broadly and across all industries, there is little indication to suggest that companies will be able to absorb higher payroll costs in their profit margins. This suggests that the pass-through from wages to core inflation will be relatively strong.⁷ However, capacity and demand pressures in the Danish economy are expected to ease slightly, which will weaken companies’ possibility of passing on higher payrolls costs to consumers. Also, lower indirect effects from energy will help to bring down core inflation.

Core inflation is expected to be 6.0 per cent in 2023, 3.5 per cent in 2024 and 3.0 per cent in 2025. The core inflation forecast reflects substantial domestic inflationary pressures, with domestic market-determined inflation, IMI, projected to be higher than core inflation, while, based on the forecasts of a number of international organisations, imported consumer price inflation is assumed to be about 2 per cent. Headline inflation is projected to decline significantly to 3.8 per cent in 2023 and 3.0 per cent in 2024 and 2.6 in 2025, i.e. as a result of lower consumer energy prices. Inflation in Denmark is projected to be somewhat lower than estimated by international organisations for the euro area in 2023, while the forecast for core inflation is in line with the euro area for the following years.

The wage and price projection implies a considerable recovery in real wages, which will grow quite strongly, especially in 2023, driven by lower energy prices. The following years will see more subdued growth, with real wages increasing only slightly faster than the projected, structural productivity growth of just over 1 per cent per year. In 2025, real wages are projected to be slightly lower than in 2021, before inflation took off; one reason is that consumer energy prices (excluding taxes) in 2025 are expected to be about 60 per cent higher than before inflation took off.

However, during the projection period, wage growth will bring the wage share, i.e. the share of value added going to employees, back to slightly above pre-pandemic levels when excluding production abroad under Danish ownership and directly related costs, see chart 8. Wages will increase while corporate earnings in energy supply and transport companies come back down as energy prices and freight rates decline. Therefore, earnings per unit are not expected to contribute to higher prices in the private sector in the coming years.

Significant global monetary policy tightening

Central banks in most countries have tightened monetary policy significantly since early 2022 to bring down inflation, and Danmarks Nationalbank has generally continuously followed the ECB’s interest rate hikes. Tighter monetary policy and high inflation have led to higher mortgage rates and bank interest rates for Danish households and companies.⁸ At the same time, banks have tightened credit standards. Overall, financial conditions have been tightened substantially, and credit growth has weakened both in Denmark, the euro area and the USA.

Higher wage growth provides a lower limit for the decline in house prices 

House prices declined steadily in 2022 on the back of interest rate hikes and high inflation, but in spring 2023, they picked up slightly. Since their peak in April 2022, prices of single-family houses have decreased by 8 per cent, or somewhat less than might be expected given the substantial interest rate hikes and high inflation. Recent developments are in line with several other countries, including Sweden and the USA where house prices are increasing, while developments are flat in Norway and the UK, see chart 9. Among our usual benchmark countries, Swedish and Danish house prices have still declined the most since their peak in 2022, despite the increases seen in recent months. However, Danish and Swedish house prices were also the first to start falling. The earlier turnaround could be associated with the relatively fast transmission of monetary policy to Danish mortgage rates, occurring as a result of the mortgage credit system in which homebuyers’ mortgage rates are determined on market terms.

In 2022, higher interest rates and inflation both took a toll on homebuyers’ disposable amounts, causing house prices to decline. Since then, inflation has come down and does not add further pressure to the housing market. Lower energy prices have reduced housing costs and could be part of the explanation for the slowdown in house price declines. Also, employment is high, which underpins purchasing power in the housing market. In 2023, income growth will ensure higher real disposable incomes, and real disposable income growth is expected to pick up in the coming period following the spring collective bargaining rounds. This contributes to pushing up nominal house prices.⁹ Housing costs as a share of income, the ‘housing burden’, have risen over the past eighteen months, to a higher level than seen in the 2010s when Danish households spent a relatively small share of their income on housing, see chart 10. The current level is not high in a historical context.

Danish house prices are expected to increase slightly during the rest of 2023 before picking up halfway into 2024. Market expectations indicate that interest rates will drop only slightly over the coming years; as a result, interest rates, along with an expected contraction in employment, will continue to dampen house price growth. Single-family house prices are projected to drop 3.2 per cent in 2023 and then grow 0.7 and 2.1 per cent, respectively, in 2024 and 2025. So, house prices will remain below their latest peak over the projection horizon. The 2023 price fall, measured as annual averages, reflects the sharp house price declines in 2022, as house prices in late 2023 are expected to have picked up slightly from the beginning of the year.

New housing taxes will take effect on 1 January 2024. This will restore the effect of a key automatic stabiliser in the housing market, given that housing taxes will again rise and fall with house prices, which will dampen house price fluctuations. The housing tax reform will create a more uniform tax regime across geography and property types. Viewed in isolation, the new housing taxes are expected to translate into a small increase in house prices and a small price drop for owner-occupied flats, but they will help dampen price fluctuations going forward.¹⁰

Higher purchasing power will boost private consumption

Household consumption started to pick up again in the 1st half of 2023 following a sharp fall in 2022, see chart 11. The recovery in household consumption is driven mainly by higher real incomes in the 1st half of 2023, as employment has continued growing and real wages have increased as a result of lower energy prices.

Consumer confidence has also improved considerably since the autumn 2022. The improvement in private consumption and consumer confidence should be seen in the context that energy supply uncertainty is less pronounced than in the autumn 2022. Still, consumer confidence is weaker than anytime during the pandemic and in line with the financial crisis.

So far, the cyclical decline in consumption is more advanced in Denmark than in the euro area and the USA, although households are largely facing the same global impacts. The difference is due both to differences in financial support to households during and after the pandemic¹¹ and to the fact that some of the effects of monetary tightening have been transmitted faster to households in Denmark than in the euro area.¹²

The improvement of household purchasing power is expected to continue in the coming period as wage growth accelerates further. Purchasing power increases although, viewed in isolation, the tightening of monetary policy significantly weakens purchasing power in 2023 as households’ interest costs rise¹³. From the 2nd half of 2023 to the end of 2025, real incomes are expected to rise about 1 per cent per year because the relatively high wage growth offsets the decline in employment starting towards the end of 2023. This means that the loss of purchasing power in 2022 will gradually be recouped, and in the course of 2025 real disposable incomes will be back to pre-inflation levels.

Private consumption growth is expected to continue throughout the projection period, with consumption projected to increase in line with the improvement in purchasing power, see chart 12. Consumption relative to income, i.e. the consumption ratio, is estimated to remain at pre-pandemic levels. This is relatively low in a historical perspective.¹⁴

Global growth is slowing following the past year’s interest rate increases

Global economic growth is expected to slow over the coming years. For instance, the International Monetary Fund, IMF, forecasts that the economies of the euro area and the USA will grow only slightly in 2023 and 2024, see chart 13. On the other hand, the real wage declines of 2022 are set to reverse to a moderate recovery before long. Business expectations for the coming quarters are mixed. The service sector expects a small slowdown, while construction and manufacturing, especially in the euro area, expect a more substantial drop in activity.

Euro area growth was weak in the 1st half of 2023, and the business confidence, measured by the Purchasing Managers’ Index, PMI, indicates that the slow growth has continued over the summer. A key reason is weak private consumption, probably impacted by higher prices and monetary policy interest rates. In the USA, strong wage growth and ‘dissaving’ of financial wealth accumulated during the coronavirus pandemic translated into higher private consumption and solid growth in the 1st half of 2023.

Slowing inflation, high employment and wage growth may boost economic growth in the coming quarters, thereby continuing to contribute to the recovery in real income and consumption. On the other hand, the outlook is for weaker global demand and tighter credit conditions, driven by high monetary policy interest rates.

The European Commission expects a gradual tightening in the euro area fiscal policy stance in 2023 and 2024. However, this should be seen in the context of the relatively accommodative stance in 2022 when the euro area countries launched a number of major energy relief packages. Also, the tightening of fiscal policy requires the euro area countries to phase out their relief packages during the period; this is not a given because several member states are still extending such measures, while a few others are introducing new ones.

When China abandoned its zero-tolerance approach to coronavirus in December 2022, expectations were that China’s reopening would boost global demand. But following a strong, though short-lived, recovery in the 1st quarter of 2023, the momentum of the economic recovery has slowed, which is evidenced also by the drop in business and consumer confidence.  Since spring, the slowdown in the Chinese economy has been dampening international growth prospects.

Slowdown in export market growths weakens exports and investment

Already at this stage, Danish companies seem to be impacted by the slowdown in growth abroad. Growth in large Danish export segments is also expected to be subdued going forward, given that growth abroad remains relatively weak due to monetary policy tightening.

So far, pharmaceutical production has been keeping overall Danish exports and GDP afloat, while the rest of the manufacturing industry is in downturn. Pharmaceutical industry growth seems to be driven largely by subcontractors abroad; this growth is included in Danish exports and value added because production takes place under Danish ownership, see box 2.

Based on market analyst expectations, pharmaceutical production and exports of a number of large pharmaceuticals in Denmark are also projected to rise sharply in the coming years. Also in the coming years, this growth is expected to help boost Danish exports considerably. On the other hand, excluding pharmaceutical production and exports, Danish export growth is projected to be roughly in line with growth in Denmark’s export markets, indicating that Danish wage growth will be in line with wage growth abroad. So, the underlying outlook is for relatively subdued growth in Danish exports of goods. However, the strong growth in pharmaceutical production and exports implies that, overall, the market shares of Danish export companies are expected to increase further during the projection period, see chart 14. Exports of services are also projected to rise in line with growth in Denmark’s export markets. Overall, exports are expected to grow by 7.0 per cent in 2023, 3.8 per cent in 2024 and 3.6 per cent in 2025.

Corporate investments are expected to decline by 4.1 per cent in 2023. The sharp fall is attributable to slow growth in most Danish export companies and higher corporate financing costs. However, total corporate financing costs have not increased nearly as much as the price of debt financing, given that the price of equity financing has edged up only slightly since 2021.¹⁵ Moreover, a large single patent investment at the end of 2022 reduces annual growth in 2023¹⁶. Towards the end of the projection period, investments will pick up slightly as the tightening of monetary policy will be fully transmitted to corporate investments.¹⁷

Slowdown brings the Danish economy close to a neutral cyclical position

Aggregate demand in the Danish economy is projected to be relatively weak in the coming year, and the Danish economic slowdown is expected to persist a little longer. Private demand, in particular, will be weak for the rest of 2023, with declining residential and corporate investment and weak growth in private consumption and exports, excluding production abroad under Danish ownership, see the description earlier. Aggregate demand is projected to grow 1.6 per cent in 2023, resulting in estimated Danish GDP growth of 1.7 per cent, given that import growth is projected to be slightly weaker, at 1.3 per cent.

Private demand growth is expected to pick up slightly in 2024 as the decrease in residential and corporate investment slows a little. GDP is projected to grow 1.3 per cent in 2024 and 2025, but the 2024 figure includes relatively large contributions from public consumption and the reopening of the Thyra gas field.

Viewed in isolation, the sharp increase in production abroad under Danish ownership is estimated to contribute about 2.5 percentage points to GDP growth in 2023, 0.5 percentage points in 2024 and 0.3 percentage points in 2025. So, excluding production abroad under Danish ownership, the level of economic activity in Denmark declines in 2023, and growth will be quite weak in 2024 and 2025. Therefore, growth excluding production abroad under Danish ownership is expected to be slightly weaker than abroad, where a mild growth pause with no decrease in activity is assumed. 

Capacity pressures in the Danish economy are assessed to have eased considerably since early 2022, driven by the slowdown in growth excluding production abroad under Danish ownership. The large contribution to GDP from production abroad under Danish ownership is matched by a corresponding contribution of around 5 per cent from 2020 to 2025 to the estimated potential output level that is compatible with stable wage and price growth, see chart 15. Moreover, the reopening of the Thyra gas field, the abolition of Great Prayer Day as a national holiday and a large influx of foreign labour also contribute to relatively high potential growth.

With prospects of a continued economic slowdown in Denmark in the next six months and high potential growth, the output gap, i.e. the difference between actual output and the estimated potential output, is projected to narrow further. During 2024, growth is expected to be in line with potential growth, and the Danish economy is projected to be close to a neutral cyclical position. However, the outlook for the Danish economy is contingent on inflation being brought down without sending the global economy into recession. Currently, international organisations such as the International Monetary Fund, IMF, forecast that recession will be avoided.

Continued outlook for large balance of payments surpluses

In the coming years, the balance of payments surplus is expected to remain around 12 per cent of GDP until 2025. In 2022, the services trade surplus was boosted by exceptionally high freight rates, but freight rates are back down, and the services trade surplus is now in line with the pre-pandemic years, see chart 16.

Over the past year, the pharmaceutical industry’s strong growth in production abroad under Danish ownership has helped improve the balance of goods; however, this is partly offset by pharmaceutical prices, which seem to have declined. Moreover, since autumn 2022, the energy trade deficit has been reduced as energy prices have decreased, and the deficit is projected to reverse to a surplus in the coming years with the reopening of the Thyra gas field and higher North Sea production. Throughout the rest of the projection period, the balance of payments surplus is projected to be about 3.5 percentage points higher than in the pre-pandemic years, an increase that is largely driven by production abroad under Danish ownership.

Fiscal policy is neutral for growth in 2024

Danish fiscal policy was tightened considerably in 2022 and 2023, and more so than in the euro area. No further tightening is envisaged in the 2024 Finance Act, in which fiscal policy is assessed to be neutral for growth although the government budget surplus is projected to be slightly lower than in 2023.The Danish Ministry of Finance estimates that the 2024 fiscal policy stance is largely neutral for the capacity pressures in the Danish economy measured by one-year fiscal effects, which are determined at 0.0 percentage points.¹⁸

In 2023, the government budget surplus is projected to be 3.1 per cent of GDP, representing a slight weakening from the 2022 surplus of 3.4 per cent of GDP. The large surpluses should be seen in the context that high inflation improves public finances in the short term, as higher wage and price increases improve tax revenues relatively quickly, while public wage expenditure and income transfers are adjusted to private wage growth with a lag. However, in 2023 and 2024, disbursement of overpaid housing tax weakens the government budget balance.¹⁹ The government budget surplus is projected to weaken further to 2.0 and 2.2 per cent of GDP in 2024 and 2025, driven by relatively large increases in income transfers and public wage expenditure as these are indexed and adjusted, respectively, to account for private sector wage growth.

Labour market defies slowdown in growth

The Danish labour market is still growing, although the slowdown in growth seems to have manifested itself in most segments of the Danish economy. However, there are indications that the momentum of the labour market is slowing down, and the current employment growth is projected gradually to reverse to a small decline over the coming years.

Employment has grown by 40,000 people in the past year, and during the same period, unemployment has risen only slightly from a low level. The same applies to the euro area and the USA, where employment is still growing, and in the euro area unemployment rates are currently at their lowest ever.

In Denmark, employment growth is driven mainly by an increase in working elderly people and by a large influx of foreign labour. This means that the labour force has expanded significantly, while the employment rate of 30-59-year-olds has risen only slightly.

Employment has grown in most industries, with a sharp increase in non-manufacturing employment, which has otherwise been the driver of growth in Danish production. With the underlying slowdown in the Danish economy since early 2022, this means that productivity growth has been weak. In Denmark, private sector productivity has fallen by up to 5 per cent, excluding production abroad under Danish ownership and directly related costs, see chart 17.

Weak productivity growth is not an isolated Danish phenomenon; employment growth in the euro area and the USA has also been strong relative to GDP recently, and this has generally taken major economic institutions by surprise in their growth outlook.²⁰ In the USA, productivity growth has been stronger as a result of less distortive labour market policy measures following the coronavirus pandemic, among other factors.²¹

Weak productivity growth probably suggests that the slowdown in production has yet to impact employment. Historically, employment has responded with a lag relative to production,²² but there may be several explanations why the impact has yet to be passed through to the labour market in the current situation.

Firstly, tight labour markets at the peak of the global boom could mean that employment has grown because many people from the fringes of the labour market with low productivity have entered the labour market, which is often seen during a boom period.

Secondly, weak productivity growth may also be the result of labour hoarding, with companies retaining employees at the start of a downturn while waiting to see the depth of the downturn.²³ Currently, this impact could be especially pronounced because companies have been reporting exceptional recruitment difficulties in many segments of the economy, and the number of hires per vacancy is lower than in the pre-financial crisis years.

With prospects of a persistently weak growth trajectory in Denmark, employment growth in terms of number of people is also projected to slow gradually and reverse into a slight downturn by the end of 2023, see chart 18. This expectation is underpinned by a considerable decline in the number of job postings. However, we are not likely to face a significant downturn in the labour market because companies’ reported labour shortages are still slightly higher than before the pandemic. Employment is estimated to fall by 40,000 people from the end of 2023 and towards the end of 2025, entailing that total productivity growth will be just under 2 per cent per year until the end of the projection period. 

Productivity growth is projected to be relatively high in a historical context, but still lower than in the post-financial crisis years. The employment estimate means that the employment gap will gradually narrow towards the end of 2025, but employment will still be above its structural level.

Unemployment is estimated to grow by 20,000 people by the end of 2025, thereby remaining slightly below its structural level, see chart 19. In other words, the labour market downturn will be relatively mild.

Risk outlook is linked to persistently high inflation

The risk outlook for the Danish and international economy largely depends on the speed and effectiveness of monetary policy transmission to growth and inflation; these effects will be instrumental in bringing down inflation. The energy supply situation and developments in China, including geopolitical US-China tensions, also carry risks.

Central banks have adjusted their monetary policies to bring inflation under control, and judging by market expectations, analysts still believe they will succeed. Although central banks are prepared to adjust their monetary policies, it may not be possible to adjust monetary policy quickly enough to avoid a recession. For instance, if the pass-through of interest rate hikes is stronger than expected. On the other hand, a recession may also occur if the pass-through of monetary policy tightening has not been strong and fast enough to avoid a slide in inflation expectations, entailing that a recession is necessary to bring down inflation to target.

A strong pass-through of interest rate hikes carries the risk of a flare-up of the financial turmoil seen in the spring. This risk scenario could, for instance, materialise because of the interest rate hikes already implemented, or because more interest rate increases than expected will be needed. See box 3 for modelling of a scenario of severe tightening of US credit conditions.

Due to the supply situation in the energy market, there is also still considerable uncertainty about inflation. If the supply situation worsens, this could lead to higher energy prices, which will increase inflation and weaken household finances and potentially weaken consumption and the housing market. On the other hand, an improvement of the supply situation in the energy markets could also accelerate consumption, house prices and capacity pressures in the economy.

Developments in China are of great significance to the risk outlook for the Danish and international economy. According to the IMF’s July forecast, about 30 per cent of global growth in 2023 and 2024 is expected to be generated by Chinese growth. Therefore, the outlook for the global economy will weaken considerably if the Chinese economy grinds to a halt. Several current challenges could pose a major risk to China’s economic stability. One risk is heavy indebtedness in the Chinese property sector and large shifts between supply and demand, which could trigger a sharp fall in house prices. In that case, a sharp contraction in investment and private consumption is likely, given that activity in the property market and the construction sector has been the driver of Chinese growth. Another risk factor to the Chinese economy is geopolitical tensions between the US and China, which could result in more trade and investment restrictions. This could hamper global trade and increase inflationary pressures by causing new international supply chain challenges, see box 4. These challenges could trigger a sharp fall in Chinese growth that will have a spill-over effect on Danish and global economic growth. For example, Danmarks Nationalbank’s calculations show that a 1 percentage point growth decline in China could reduce Danish GDP growth by 0.4 percentage points after one year.²⁴

There is considerable uncertainty about GDP growth the coming years as Danish-owned production abroad may be scaled up relatively quickly because of for example change in ownership structures of Danish subsidiaries etc. However, production abroad does not significantly affect the outlook for capacity pressures because only a small share of employment in Denmark is directly linked to this production abroad.

The projection has been prepared using Danmarks Nationalbank’s macroeconomic model MONA and is based on available economic statistics, including Statistics Denmark’s quarterly national accounts for the 2nd quarter of 2023.  The projection is based on statistics published up to and including 12 September 2023. The projection also includes a number of assumptions concerning the international economy, financial conditions, labour force developments and fiscal policy.

International economy

Export market growth is assumed to be 0.8 per cent in 2023, 3.0 per cent in 2024 and 3.1 per cent in 2025, see table A1. Wage growth abroad are is to amount to between 4 and 5 per cent over the next three years. Price increases of imported goods and services are assumed to slow down sharply and stabilise at just under 2 per cent. Assumptions are based on the latest OECD forecast and adjustments based on forecasts and economic data of other international organisations since then.

Interest rates, exchange rates and oil prices

Developments in short-term and long-term interest rates in the projection are based on the expectations of future developments that can be derived from the yield curve in the financial markets. Against this backdrop, the 3-month money market interest rate as measured by the CITA swap rate is assumed to rise a further 0.1 percentage points towards the end of this year, peaking at 3.3  per cent. It will then gradually decline throughout the projection period to 2.7 per cent by the end of 2025.

In the projection, the effective krone rate and the dollar rate are assumed to remain constant at their current levels.

Energy prices are generally expected to follow the development in oil prices, which are assumed to follow futures prices during the projection period. Due to the large fluctuations in energy prices, the oil price in the projection is determined on the basis of an average of futures prices for 6 days prior to the completion of the underlying data. In early September, the oil price was around 90 dollars per barrel, and it is expected to decrease gradually to just over 80 dollars per barrel at the end of 2025.

As in Danmarks Nationalbank’s projections since March 2022, this projection also takes into account the current situation with unusual developments in gas and electricity prices. As for oil prices, gas prices are assumed to follow futures prices going forward, and they are assumed to increase for the rest of 2023 to about kr. 370 per MWh from their current level of kr. 250 per MWh, and then to fall to about kr. 350 per MWh by the end of 2025. Electricity prices are assumed to follow futures prices for the first five months, but because few contracts are traded for delivery more than five months ahead, electricity prices are subsequently assumed to follow futures prices of gas. Against this backdrop, electricity prices are assumed to lie more or less stable around euro 100 per MWh. Therefore, the price of electricity and gas is assumed to remain higher than in 2019.

Fiscal policy assumptions

The projection is based on preliminary national accounts data on public-sector consumption and investment as well as the Finance Bill in Economic Survey, August 2023 and the medium-term scenario in Updated 2030 development, August 2023. On this basis, real public consumption is expected to increase by 1.0 in 2023, 2.5 per cent in 2024 and 1.3 per cent in 2025. Public investment is expected to fall by 0.2 per cent in 2023 and increase by 4.4 per cent in 2024 and 1.5 per cent in 2025.

Revisions in relation to the previous projection

Projected GDP growth has been revised upwards by 0.8 percentage points in 2023 and 0.1 percentage points in 2024 and 2025, see table A2. Revised assumptions of export market growth, interest rate developments and exchange rates contribute to dampening growth in all years. The upward revision in 2023 reflects other factors, mainly covering the sharp increase in production and exports of pharmaceutical products, including production abroad under Danish ownership.

The forecast of the rate of increase in consumer prices, HICP, is adjusted down by 0.2 percentage points in 2023, 0.6 percentage points in 2024 and 0.4  percentage points in 2025. Changed assumptions of oil prices and foreign wages and prices contribute to adjust the inflation forecast in 2023 downwards, while changed interest rate assumptions contribute to dampening inflation in all years up to 2025. The negative contribution from other factors partly reflects assumptions of lower electricity and gas prices. Other factors also come into play, as electricity and gas prices have developed more than the normal oil price pass-through suggests.