Saturday, November 6, 2010

Scandi Update

Denmark: Large budget deficit
Statistics Denmark published its public sector accounts for 2009 during the week, giving us definitive figures for the size of last year’s budget deficit and public consumption. In its latest Economic Survey, the Ministry of Finance estimated the general government budget deficit in 2009 at DKK47bn, and this figure is now confirmed – there have been no changes on that score.

Public consumption grew by 6.8% in current prices, slightly below the 7.0% indicated by the latest national accounts data. However, this difference needs to be seen in the light of an upward revision of public consumption in 2008, leaving growth from 2008 to 2009 slightly lower than previously estimated. All in all, public consumption in 2008 was revised down by DKK80m, or 0.02% – in other words, hardly at all.

So we still have to conclude that there were serious problems with fiscal discipline in the public sector in 2009. The need for a fiscal recovery plan is to a great extent due to growth in public consumption having been higher than budgeted for many years, and the growth differential was particularly marked last year.

It is therefore inevitable that we will see lower growth in public consumption in the coming years, whatever the government. The current government’s recovery plan is looking for zero growth in real public consumption, whereas the Social Democrat/ Socialist People’s Party budget proposal aimed at real growth of 1.4%. In both cases, though, growth in public consumption is lower than we have seen in recent years, and so many will view these plans as austerity packages, even though this is not actually the case at an aggregate level.

Whatever the government, it will remain hard to realise expectations for growth in public consumption in the coming years. Although the fiscal recovery plan includes various sanctions for local authorities, we still have to be sceptical about whether this is enough to keep spending at planned levels.

Sweden: On the peak
Last week’s business confidence data from the National Institute for Economic Research (NIER) demonstrated a slight slowing of growth. The PMI data recently published did confirm that reading but rather added to the general impression of a very strong Swedish economy. Despite slower domestic order growth, export orders rose quite vigorously, which we feel is a more solid sign of strength for a small open economy such as Sweden. Also, the employment index continues to post strong readings, which bode well for the short-term outlook for the labour market.

Norway: Encouraging PMI, stable unemployment
The week brought a series of data suggesting that activity in the Norwegian economy is growing in line with our – and probably also Norges Bank’s – expectations. The PMI climbed from 53.1 in September to 54.2 in October. It was encouraging that industrial orders rose sharply, while the production index fell marginally. Statistics Norway’s business tendency survey for Q3 showed a moderate rise in industrial output, with further growth expected in Q4. 12-month credit growth (C2) climbed from 4.6% in August to 4.8% in September, with both businesses and households slightly increasing their borrowing. Seasonally adjusted house prices rose by 0.3% in October, leaving them at record highs in nominal terms but still below their 2007 peak once adjusted for inflation. LFS unemployment held at 3.4% in August, so unemployment appears to be stabilising after the decrease in the spring.

Focus - EUR/DKK: Tighter than tight
The Danish Central Bank raised the deposit rate 10bp to 0.70% and the current account rate 10bp to 0.60% on 28 October. This was the second rate hike in just two weeks for the Danish Central Bank and a clear confirmation that the hiking cycle is kicking off.

The hike in itself was not particularly surprising; as excess liquidity in the euro zone has been drained, short-end money market rates have risen and now exceed corresponding Danish rates up to one month. The DKK-EUR forward spread has been negative since the summer and EUR/DKK has drifted higher towards the central parity. It has been clear for a while that the Danish Central Bank had to act eventually. We argued for the latter earlier in the autumn as the currency reserve was sky-high and we believed the Central Bank would be a little relaxed on potential currency outflow: an ‘easy-come/easy-go’ argument.

We were wrong; the Danish Central has been anything but relaxed: two pre-emptive rate hikes without any warning and without the krone being under any pressure. The latest official data shows that the Danish Central Bank only spent 7.3bn DKK in euros to stabilise EUR/DKK in October before raising rates twice. However, we notice the action occurred while EUR/DKK was trading below the central parity and that the reserve remains well upholstered at 421.7bn, substantially above what can be ascribed as necessary.

The strange thing about last week’s rate hike was the justification. In the accompanying statement, the Bank said, “the increase [was] due to a raise in the short European market rates compared to the equivalent Danish market rates.” Not a word about currency outflow, which has been standard before a rate hike. This indicates to us that the Danish Central Bank has changed its reaction function and has shifted focus more towards market rate spreads than currency inflow. The implication is that the Central Bank is more unpredictable, can act more aggressively and potentially disturb financial markets if it decides to adjust rates more frequently, rather than allowing for slightly higher exchange rate volatility.

In a rare response to Reuters on whether Denmark's monetary policy has changed, Central Bank Governor, Nils Bernstein, was asked which spread the Central Bank is targeting. The rather inane answer was, “We consider the overall picture”. We can therefore only guess on what money market spread is the most important. Our assumption is that the Bank is mainly concerned about the very short end of the money market, i.e. up to one month.

The Head of the IMF’s mission to Denmark, Mark de Broeck, said on Monday that Denmark’s peg “is complicated, it requires movements in exchange rates, it requires interventions, so this type of issue can be quite costly for the central bank without any clear benefits.” We think comments like these are lost on the Danish Central Bank.

By only allowing the krone to go marginally stronger while not accepting the krone to trade weaker than the central parity, the Danish Central Bank is ‘de facto’ running a currency board at present. However, we expect to see the Central Bank allowing EUR/DKK to fluctuate slightly more going forward when official spreads are normalised. We expect to see the gap between the lending rate, the deposit rate and the current account rate being closed over the next six months. We expect to see another 10bp deposit rate and current account hike before year-end.

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