Key takeaways

  1. A moderate recession is expected to result in a decreased economic activity from an inflated level to a more stable state. This can partly be attributed to the combination of high inflation and a restrictive monetary policy aimed at achieving inflation targets.
  2. In 2023, it is projected that unemployment will rise from its present low historical level. Despite this, the economy will continue to exhibit unrelieved demand for labour, resulting in a relatively mild increase in unemployment.
  3. Inflation has likely reached its peak and should normalise due to decreasing demand and stabilising energy prices. However, a delay in costs transmitted to consumers will keep inflation elevated at the beginning of the year. 
  4. The Danish central bank will keep increasing key interest rates, which are anticipated to reach a peak in the mid-year. The rate of increase is predicted to slow as the neutral rate approaches. The interest rates are likely to decline gradually as inflation decelerates. However, the rate is expected to stabilise at a higher level. 
  5. Increasing mortgage rates will inhibit housing demand, permeating through the economy. A severe housing-induced recession is, however, unlikely due to stricter mortgage regulations and the well-cushioned finances of the Danish population. 

The Danish Economy is prepared for a modern downturn

The past year has witnessed significant economic fluctuations, including a 40-year high inflation and a sharp increase in interest rates. Based on current trends, it is projected that the Danish economy will enter a moderate recession in 2023, with a projected GDP growth of just 0.4%. However, it is anticipated that the economy will recover in 2024, with a projected growth of 2.0%.  

While traditional indicators such as GDP and government finances have yet to indicate an impending recession, other factors such as inflation and corporate financial performance have begun to deteriorate. Additionally, the expectation of rising interest rates has further clouded the outlook for the year ahead. 

Consumer confidence decreased materially in 2022, which impacted retail sales significantly. This impact is, however, believed to be relatively short-lived. On the other hand, businesses will most likely be forced to implement cost-saving measures to maintain profitability, resulting in job losses and an overall increase in unemployment during 2023. However, it should be noted that unemployment will only rise moderately as there remains a demand for labour in certain sectors. 

Despite the indicators pointing towards a recession, there are mitigating factors that suggest it will be a moderate one. One of the main reasons is the strong financial standing of both households and corporations. The tight labour market is further expected to prevent a significant increase in unemployment. Additionally, the Danish economy has a relatively low sensitivity to global industrial cycles, particularly due to the significant presence of the pharmaceutical industry. 

Figure-1

Pace of interest rate hikes to moderate

To address the high inflationary pressure, the Danish central bank, Danmarks Nationalbank, increased rates by 235 basis points (bps) through 2022. Danmarks Nationalbank has closely followed the interest rate adjustments of the European Central Bank (ECB) to maintain its fixed exchange rate policy against the euro. However, an appreciation of the Danish krone has necessitated an increase in the rate spread by 15 bps. Given the ongoing pressure on the euro to depreciate, the rate spread is anticipated to continue to widen.

Danmarks Nationalbank will likely undertake further monetary policy tightening measures, with the deposit rate projected to reach a peak of 2.8% in the middle of 2023. This forecast is, however, contingent on the progression of interest rate adjustments made by the ECB.

Long-term interest rates began to rise in anticipation of the first interest rate hike from Danmarks Nationalbank in several years. The Danish 10-year government bond is projected to reach a peak of 2.6% in early 2023, and subsequently, the yield is expected to experience a gradual decrease towards 1.8% in Q4 2025.

It appears that interest rates are approaching their peak and are expected to decline by the end of the year once inflation is under control. While this perspective may hold merit, there are potential risks to consider. The ongoing conflict in Ukraine may impede the gradual decrease in prices for energy, food, and other commodities. Additionally, the Danmarks Nationalbank's monetary policy may be excessively restrictive, resulting in a harsher economic downturn than necessary to curb inflation.
Figure-2