Taxes set to lower Danish inflation again in 2015

• Lower energy taxes are likely to lower Danish inflation by 0.2 percentage points in 2015.

• Household consumption will not be affected, as other taxes are hiked instead.

In July, a broad coalition of parties in the Danish parliament decided to scrap planned hikes in taxes on energy used for heating and replace them with higher personal taxes. That agreement has now been turned into an actual bill proposal and it is now clear that there will also be cuts to existing taxes, as some of the hikes in 2010 and 2013 will be rolled back in 2015. Based on the experience from those hikes we estimate that the law, if enacted, will cut the consumer price of electricity and heating by around 3.5%. That translates into to a drop of some 0.2% in overall CPI in both January and for 2015 as a whole. This estimate is shared by the Ministry for Economic Affairs and the Interior in a new update of their economic forecast (link in Danish). The forecast is uncertain as it depends on the present level of energy prices and on the size of indirect effects from lower costs to businesses. There are both upside and downside risks to our estimate, but there should be little doubt that taxes will be a force for lower prices next year.

The proposed bill is still at an early state and has not been presented to parliament yet. It can be changed before that following consultation with external interests and experts. A general election is due within the next year and there is a chance it could come this year. That could delay the bill but is unlikely to stop it, as both the present government and the major opposition party are part of the agreement.

We still expect inflation to pick up next year to 1.2%, on average, against 0.7% in 2014. This year has been dragged down by falling food prices, but that effect has been reversing recently and we are likely to see some basis effect from this. A weaker euro and thus krone will also push prices up. There is no doubt that underlying inflation is low in Denmark like elsewhere in Europe, but Danish CPI is stabilised a little by the inclusion of owner-occupied housing, estimated from rents in the rental sector. Even after the tax change, CPI inflation in Denmark could be slightly higher than HICP inflation in the euro area, but likely a little lower than German HICP inflation.

The cut in energy taxes will not affect household spending power, as it is financed by a 0.25 percentage point hike in the basic income tax rate and a reduction by DKK345 in the annual compensation to middle or low income persons, to compensate for energy taxes. We do expect disposable income to rise next year, but this will primarily be because of higher employment and slightly higher wage rises.