D&B has downgraded Denmark’s country risk rating by one quartile for the second month in a row, taking the rating to DB2b, as the Danish economy has been hit by the effects of the intensifying global financial troubles and a deepening currency crisis. At a time when central banks across Western Europe and North America are cutting interest rates to soften the economic downturn, Denmark has increased lending rates sharply in the wake of a weakening Danish krone. The central bank had already raised its key lending rate by 40 basis points (bp) on 7 October. On 24 October, the central bank raised interest rates again, by 50bp, taking the policy spread between Denmark and the euro-zone to 175bp, the highest ever recorded. Denmark’s key lending rate now stands at 5.50%, which is the highest in eight years. Denmark’s central bank allows the krone to move ±2.25% from a euro/krone-pegged central parity of 7.46038. Usually, the central bank mirrors the ECB’s interest rate decisions (thus indirectly following an inflation-targeting policy), but its focus on currency stability is starting to undermine Denmark’s competitiveness in the short term and might exacerbate the effects of the worsening global credit crisis. 

High interest rates weigh on consumer spending and investment activity, thus aggravating Denmark’s economic downturn. Indeed, borrowing costs have increased steadily since 2006: the Danish central bank has raised its key interest rate by 335bp in total between December 2005 and October 2008. This has put enormous pressure on Danish households, which have accumulated one of the highest household indebtedness ratios (loans relative to disposable income) in the whole EU; Danish homeowners with flex (interest-reset) loans are particularly affected. Hence, house prices are likely to fall further: the housing market, which was responsible for an upturn in household consumption in recent years, is experiencing a marked downturn, with house prices falling 1.5% quarter on quarter from Q2 to Q3. Overall, house prices have fallen by more than 5% since peaking in 2006; this has further undermined households’ ability to spend out of housing wealth. Therefore, it is not surprising that the latest consumer confidence indicator, produced by Statistics Denmark, fell sharply from -11.1 in September to -16.6 in October, the lowest level since November 1989. Danish consumers are increasingly worried about the country’s and their own economic prospects. 

The currency crisis comes at a time when the Danish economy is undergoing a cyclical economic slowdown and is under additional pressure from the global financial crisis. Weakening lending conditions have increased downside risks to household consumption. Hence, we expect economic growth to be subdued in 2008, while falling consumption is likely to cause an economic contraction in 2009.