Economic developments

Global economy

The pace of the upward trend that can now be observed in virtually all large national economies will show another slight increase overall in the current year. In its year-end forecast the Kiel Institute for the World Economy expects global output to grow by 0.1 percentage points in 2018 to 3.9%. The principal reason why stronger growth is not anticipated is the already high level of production capacity utilisation.

The upturn in advanced economies, which include the United States, Japan and Germany as well as 30 other economically developed countries, will lose scarcely any impetus: after 2.4% in the financial year just ended, growth in the current year is expected to reach 2.3%. Economists expect to see a continuation of expansionary monetary policy, albeit on a slightly more muted scale, increased stimuli from the financial policy side and a fresh resurgence in demand from developing and emerging nations.

The world economy is again faced with numerous political risks in the current year. While the widely held fear that the new US administration might appreciably harm global economic growth through a pivot towards protectionism has so far failed to materialise, the scepticism expressed by the US government towards multilateral agreements could produce unexpected outcomes at any time. In Europe, the current efforts to secure independence for Catalonia clearly highlight the considerable fragility that still permeates the European Union. Risks associated with monetary policy are also taking on greater prominence again. It is entirely possible, for example, that the approaching normalisation of monetary policy could trigger sudden uncertainty on capital markets, triggering episodic corrections.

United States

After the US economy gathered more momentum than anticipated in 2017, the Kiel-based experts expect the growth in output to accelerate by a further 0.2 percentage points to 2.5% on the back of the robust state of the economy. Key drivers here are sustained positive consumer sentiment, rising disposable incomes and swelling corporate profits. The latter will be further boosted by the corporate tax reform passed in December, hence leaving room for the forecast to be revised upwards. With financing conditions still favourable, capital spending is also likely to be highly stimulated.

Europe

In the Eurozone, too, the upturn in cyclical activity is set to continue. Industrial output is high and new orders in the manufacturing sector are very brisk, prompting the experts at the Kiel Institute for the World Economy to forecast expansion of 2.3% for 2018. France should be able to modestly extend its growth (+2.0%), with expansion in Spain set to continue at a slower pace (+2.6%). In Italy the balance of power will probably remain problematic even after the parliamentary elections scheduled for March 2018. This also dilutes the potential for economic stimuli, and growth is therefore likely to stay stubbornly low (+1.5%). The recovery in Greece is expected to continue (+2.1%).

In the United Kingdom the uncertainties surrounding Brexit continue to prove a drag on growth, which will likely show another modest decline to 1.4% with a sustained downward tendency. Despite intensive talks over the past year, it was still unclear coming into this year how a smooth transition to a new economic and political framework could be structured for both sides.

With the upswing set to continue, unemployment in the Eurozone is forecast to decrease further from 9.1% in the previous year to 8.5% in the current year. Given the increasingly high utilisation of production capacities, core inflation in the Eurozone will probably see a further gradual increase. The overall rise in consumer prices will, however, likely be on a par with the previous year at 1.7% because oil price effects will work against inflation.

Germany

The Kiel-based economists expect the positive trend in Germany to see a further slight improvement in 2018, hence boosting growth in gross domestic product by two-tenths of a percentage point to 2.5%. With utilisation levels already far above normal, production capacities are close to their limit. Supported by income gains, private consumption will keep on rising, while the construction boom is set to continue in view of unchanged favourable financing conditions. Corporate investments will be another growth driver, as companies increasingly cast aside their reluctance to spend in view of high capacity utilisation and excellent business prospects.

Exports will likely receive another boost from the surging global economy and rise by 5.0% (previous year: 4.3%). Most notably, exports of goods to the Eurozone and Asia will be further expanded. The import side will gain added impetus from the lively state of the domestic economy, with the value of imported goods forecast to grow by 5.7% in the current year (4.8%).

China, India, Japan

The Kiel Institute for the World Economy expects growth in China to experience a further slowdown in 2018, declining to 6.4%. Whereas in recent years the government has been able to stabilise the economy through a more expansive fiscal and monetary policy, it is now dialling this back in favour of qualitative targets. With this in mind, it is focused on stemming rising indebtedness and on the overdue structural transformation towards a service-oriented economy with growth that is socially and environmentally more sustainable.

Following the successful implementation of reforms, India’s economy will be able to pick up the pace of expansion again and should grow by 7.3% in 2018. Measured by the size of its economy, India will thus move past the United Kingdom and France to become the fifth-largest national economy in the world.

The pace of growth in Japan, on the other hand, will likely ease somewhat in 2018 to 1.5%, with a further downward trend. While the country is enjoying its longest growth stretch in more than 16 years, this is being driven primarily by strong export demand. Domestic demand, by contrast, remains soft.

Capital markets

In 2018 financial markets are again likely to see promising growth opportunities but also an abundance of volatility and uncertainty. Most significantly, geopolitical risks and protectionism have continued potential for adverse repercussions in some areas. Attention will be focused on two main arenas: firstly, Europe, where it is still impossible to foresee how the Brexit vote will be translated into political and economic reality and, secondly, the United States, where moves by political actors are difficult to predict and may disturb the existing balance due to their impact on global politics.

The basic starting point for the world economy should nevertheless be assessed as positive, since none of the major world economies is in or entering retrocession; instead, they moving in relative lockstep on an expansionary course for the first time in quite a while. The Eurozone is enjoying a stable upturn and benefiting from low interest rates and what is still a comparatively weak euro. The US economy can profit from a historic package of tax reforms, although it remains to be seen whether this is reflected in real economic factors since many business actors likely realise that low taxes today can mean higher charges down the road. Increased commodity prices should, however, assist the economic recovery in numerous emerging markets.

With its announcement that it would scale back its monthly corporate bond purchases but at the same time extend the programme until at least September 2018 against the backdrop of a historically low reference rate, the ECB is standing by its policy of ultra-low interest rates. A change in the key interest rate cannot be expected until well after the bond purchases have stopped. This is intended to support business activity in the Eurozone and bring inflation back towards the ECB’s 2% target. More and more voices are, however, drawing attention to the growing dangers of this policy for business and the markets.

In contrast, the US Federal Reserve will progressively turn away from an expansionary policy in response to the economic upswing in the United States and will press ahead with the cycle of rate hikes. This may also be reflected in a strengthening US dollar. Observers are keenly waiting to see how the upcoming personnel changes at the Fed will affect its policy. The new faces, just like the old ones, will face the challenge of keeping inflation under control without jeopardising domestic consumption as well as a need to combat systemic risks with an appropriate overall policy framework.

Central banks will therefore be compelled to strike a new balance, which may lead to elevated volatility. In this context, the goal will still be to put in place a foundation on which national economies can be less dependent on the previous extremely relaxed monetary policy.

International bond markets will thus once again see largely below-average and continued divergent interest rate levels in 2018. In the relevant currency areas for our company we expect slightly upsloping yield curves. For the most part, government bonds with higher risk premiums issued by countries of the European Monetary Union that have been the focus of so much attention of late should continue to stabilise. The prevailing credit cycle in the United States, which has proven its durability, and the stabilisation of emerging markets will continue to shape the economic environment. This may potentially be positively influenced by the ending of austerity drives undertaken by several industrial nations and by a worldwide upswing in private consumption.

Compared to the soaring valuations of US equities, which delivered another exceptional performance in 2017, equities in Europe and emerging markets are lagging somewhat behind the cycle and some markets are even seeing bubble tendencies. These could deflate quickly and trigger turmoil on other markets too. Virtually historically low risk premiums on corporate and financial bonds also suggest that a great deal of positive momentum has already been priced in and the speculative scope for further price jumps on the scale seen in recent years appears rather limited, given that central banks are now stepping away from providing markets with an unconditional supply of liquidity. The extent to which effects associated with expectations placed on Donald Trump’s economic policy – which have already been factored into valuations – may be changed by adverse geopolitical developments or restrictive trade measures remains one of the elements of uncertainty for 2018, the implications of which will not leave Europe and emerging economies untouched. After all, the question arises as to who else can invest if everyone is already appropriately invested and liquidity is tending to tighten. On the other hand, we anticipate a thoroughly positive scenario in the emerging economies, which for the most part have proven astonishingly stable in coping with volatility associated with uncertainties in China and the oil price distortions of the recent past. 2018 will thus again be distinguished by an unusual combination of geopolitical and monetary policy uncertainty as well as the risk of bubbles forming in certain asset classes and markets. All in all, it should be noted that the strongly liquidity-driven search by investors for assets offering high returns is leading to inflation in asset prices which in some areas now makes the risk / reward ratio look rather critical. To this extent, increased attention must be paid to investment decisions. Consequently, broad diversification within the investment portfolio will continue to be of considerable importance in 2018.

Insurance industry

Even though the insurance industry still finds itself facing numerous – in some cases considerable – challenges in 2018, the mood throughout the sector is gradually lifting. The reasons here include the generally good overall economic sentiment and the positive approach taken by the industry in addressing the demands of change. This includes the fact that many companies are now actively partnering with insurtechs, as new market entrants, in their business models and finding numerous points of connection for developing new products.

Two key areas drawing attention continue to be the low interest rate environment and increasingly exacting regulatory requirements: the decisions taken by the ECB in the autumn of 2017 indicate that the Eurozone will not see any quick turning away from the extremely low level of interest rates. Life insurers are particularly hard hit, having no choice but to adjust their business models. The Federal Reserve in the United States, on the other hand, continues to chart a course towards higher interest rates in 2018. Going forward, there is at least the prospect that this will also lead to a normalisation of interest rates in Europe. On the regulatory side the industry is currently grappling with implementation of the EU Insurance Distribution Directive (IDD) and the EU General Data Protection Regulation (GDPR).

The industry also remains intensely preoccupied with changes in customer expectations. Against a backdrop of advancing digitalisation, customer habits are becoming increasingly unpredictable. Expectations are also shifting significantly when it comes to benefits and services. Insurers are responding by enhancing the quality of their services, stepping up customer contact management and developing new products that live up to the changed requirements.

The pressure to act on cutting costs remains considerable, prompting companies to accelerate the drive towards digitalisation of their business processes. They are expanding automation of their back office processes and enhancing the flexibility of their IT structures, at the same time opening up further scope to improve customer care. The consolidation process that has already been ongoing in the reinsurance sector for a number of years will continue in 2018. Surplus capacities are thereby eliminated, efficiency increased and operational rigour in the process of transformation maintained on a high level.

Reinsurers are continuing to shift their focus towards the quality of the solutions that they offer. This move is also prompted by the demand side, since their insurance partners are increasingly calling for bespoke solutions. Against this backdrop insurance products are created that actively support their partners’ strategic objectives and growth targets.

The increasing need to protect against climate change, elevated political risks and the ever more important segment of cyber risks continue to open up numerous entry points for the industry to launch new products. The digital transformation, in particular, is opening up new avenues for loss prevention. Going forward, it will prompt the industry to cooperate more closely with partners from the technology sector.