Danish economic outlook impacted by solid inflation

The war in Ukraine and the related EU sanctions against Russia and Belarus weigh only modestly on the outlook for the Danish economy in 2022. The direct effects of the sanctions should be limited as Russia accounts for less than 1% of Denmark’s goods exports and only 2% of its imports. Meanwhile, Ukraine accounts for less than 1% of Denmark’s exports and imports (2020). Furthermore, the cut in Russian gas supply to Denmark, as a result of its refusal to pay in roubles, has a limited effect on the Danish economic outlook as gas accounted for only 6% of the energy mix in 2021 (and can be replaced by other sources), compared with 48% for wind, 21% for bioenergy and 16% for coal. While the direct impact is limited, the indirect one, via higher energy prices, spreads over to food and other goods because of higher production and transportation costs. This significantly affects the Danish economy, as inflation reached 8.2% in June 2022, its highest level since 1983 when the second oil price shock hit Denmark. It is expected to increase even further during the year before starting to decrease thanks to base effects (provided Russia does not stop all gas and oil deliveries to Western Europe, which would result in a further explosion of energy prices). The strong inflation has eroded households’ purchasing power, pushing consumer sentiment indicators to be at record lows. This summer/autumn, the vital savings and government support for energy prices should sustain consumption, but how long it can hold is unclear. For now, it is supported by the strong labor market, where the unemployment rate reached a 14-year low and job vacancies are close to double their pre-pandemic level. Higher wage demands are possible, but this also depends on the inflation expectations among workers and employers. To keep inflation expectations stable, Denmark’s Central Bank is expected to increase its key interest rate (the rate paid on certificates of deposit) from its current level of -0.6% (mid-July 2022) by at least 100 basis points by the end of 2022. However, the central bank is limited in its actions by the ECB’s monetary policy as the Danish Krone is pegged to the euro. The rising interest rate will also trim private expenditure, notably housing investment, as the (primarily variable) interest rates of mortgages have already risen noticeably in early summer 2022. Private investment should be limited in 2022 due to high inflation and increasing financial and geopolitical uncertainty. Furthermore, government spending will slow as the expenditures linked to aid for higher energy prices will not be offset by the end of the pandemic emergency spending schemes. In addition, this is only partly balanced out by the investments under the EU Recovery Fund, from which Denmark receives EUR 808 million for 2021-2027 for investments focusing on the green and digital transition. Still, Denmark’s outlook is better than most other European countries as Denmark has specialized in niche markets, including food products (pork and cheese), pharmaceuticals, and renewable energy technology, which are less sensitive to cyclical fluctuations.

Public budget surplus shrinks

In 2022, we expected a decline in the public budget surplus. While public consumption and investment should remain modest, the expenses linked to the war in Ukraine (support for households and firms and refugees and defense expenditures) will have a noticeable impact on the budget. Accordingly, the gross public debt load will shrink slightly slower but remain very low in European comparison. The current account surplus should remain strong. While the goods trade surplus should decrease somewhat due to the softening demand from Denmark’s trading partners in Western Europe, this should be leveled out by a more robust services trade surplus as the demand for shipping services is further increasing and tourists are coming back.

Social-democratic government with a conservative policy

Since June 2019, Prime Minister Mette Frederiksen from the Social Democratic Party (SD) has been leading a minority government with the support of the other “red-block” parties: the Social Liberal Party, the Socialists People’s Party, the Red-Green Alliance, and three minor parties from Greenland and the Faroes Islands. Thanks to the generally successful handling of the pandemic, in combination with popular right-wing immigration policies and a divided conservative/right-wing opposition, popular support for the SD has remained high. Frederiksen, for now, has also survived a political scandal around her illegal order to kill all living mink in Denmark in November 2020, as a prophylactic measure to avoid a further spread of a new mutation of the COVID-19 virus. A parliamentary commission announced that her statements were “grossly misleading.” Still, they did not conclude Frederiksen was guilty of gross negligence as she did not know that her order was illegal. However, with the war in Ukraine, the focus of the public changed. The Danes voted on 1 June 2022 to join the European Union’s defense and security standard policy, ending a 30‑year opt‑out. As the Danes favor stability in the current uncertain situation, Frederiksen should remain in office until the next regular election in 2023.