The growth of the world economy lost momentum in 2018. The increase in global gross domestic product (GDP) was on a par with the previous year at 3.7% (previous year: 3.7%). Two major reasons here were rising trade tensions and the tightening of monetary policy in the United States. The latter prompted a reversal in the flow of international capital, hence putting the brakes on expansion first and foremost in emerging markets. After a moderate opening quarter global output put on another vigorous surge going into the summer, before suffering a sharp drop in impetus from the third quarter onwards. While business sentiment in advanced economies picked up again towards year-end, it remained depressed in emerging nations. This was exacerbated by a worsening economic outlook in China.
While economic developments across countries had moved in step with one another in the previous year, the picture in 2018 was more nuanced: the pace of expansion in the US gained added momentum from fiscal measures, whereas in the Eurozone and Japan the economy slowed. In emerging economies the story was a similar one: growth in manufacturing output eased only marginally in many Asian countries, in Russia and in parts of Latin America, while Argentina and Turkey slipped into recession.
Looked at over the year, the pace of growth in the advanced economies faded in 2018, primarily owing to the slowdown in expansion during the second six months. The US economy, on the other hand, proved relatively robust on the back of a continued rise in consumer demand. In Japan, contrary to expectations, the economy softened both domestically and on the international front. Momentum in the Eurozone economy was similarly slowed by a number of factors, including the decline in car manufacturing owing to the adoption of new standards for exhaust emissions measurement. Manufacturing output in the United Kingdom contracted again from the moderate level already seen in the previous year.
Even though emerging market economies came under pressure in 2018, they were still comparatively stable. With the exception of Argentina and Turkey, the decline in their manufacturing output was merely modest. Fears voiced on occasion that this group of countries could suffer economic downturns similar in scale to those of 1997 / 98 owing to the intense pressure on financial markets proved unfounded. This is due in part to the fact that emerging nations have now largely adopted more flexible exchange rate regimes and hence are less vulnerable to currency speculation. In Asian countries the growth rates remained high overall despite slight contractions in GDP, while in India the pace actually increased. Manufacturing in Russia continued to trend clearly higher, and in Brazil growth in output recently began to pick up again – albeit from a low level.
The trade measures adopted by the US since the beginning of 2018 in pursuit of its economic policy goals significantly aggravated the potential for conflict not only with China but also with western industrialised nations. So far, however, this has not adversely impacted the upward trend in the country’s economy. Whereas in other advanced industrial nations the economy slowed appreciably in the third quarter, GDP growth in the US was only a little softer than in the previous quarter. Over the year as a whole US manufacturing output rose by 0.7 percentage points to 2.9% on the back of normal capacity utilisation. Unemployment continued to fall year-on-year to an extremely low level of 3.9%. The increase of 2.5% in consumer prices was again more marked than in the previous year.
The Eurozone economy was unable to sustain the vigorous upward course that it had charted in the previous year: the pace of growth slowed by 0.6 percentage points year-on-year to 1.9%. The economy already suffered a sharp drop in momentum in the first six months, only to lose further impetus in the second half of the year. Domestic economic forces were even more crucial to driving expansion in 2018 than in the previous year. The role played by external factors diminished against a backdrop of falling imports and exports. While capital expenditure rose again slightly thanks to a favourable interest rate environment, private consumption expanded at a considerably reduced pace. Government consumption expenditures were also substantially more restrained than in the previous year.
Looked at individually, it is evident that some Eurozone countries – including Germany – were increasingly coming up against capacity constraints in 2018. In other countries, most notably Italy (GDP: +1.0%) and France (GDP: +1.6%), economic development is hampered by structural problems. The two crisis-hit countries of the past years, namely Portugal (GDP: +2.1%) and Greece (GDP: +2.3%), were able to stabilise their growth trajectory. The UK economy posted growth of 1.3% amid a cloud of uncertainty surrounding what form Brexit will take, a figure which was again poorer year-onyear.
The state of the labour market continued to improve, with the average jobless rate in the Eurozone falling by 0.9 percentage points relative to the previous year to stand at 8.2%. Nevertheless, Greece, Spain and Italy still struggled with very high levels of unemployment.
The harmonised index of consumer prices increased by 0.3 percentage points year-on-year to 1.8%, hence approaching the ECB’s target of 2%.
In 2018 the German economy was able to sustain the upswing seen in recent years. Growth is, however, progressively grinding to a halt. Indeed, economic output actually contracted for the first time in three years in the third quarter. The reasons – productions disruptions in Germany’s vitally important automobile manufacturing industry and transportation difficulties on inland waterways – are merely temporary in nature. Nevertheless, businesses are finding it increasingly difficult to keep expanding production at a vigorous pace in view of the high capacity utilisation rate. This is especially obvious in the construction sector. Viewed over the year as a whole and after working days adjustment, gross domestic product rose by 1.5%, a drop of 0.7 percentage points compared to the previous twelve months.
The decline in vehicle manufacturing not only impacted upstream and downstream sectors of the economy, it also had implications for the domestic and external expenditure components of consumption, capital expenditure and exports. Private households exercised restraint despite rising incomes, with spending increasing by 1.1% (1.8%). Companies were similarly hesitant to boost their capital expenditures – the increase of 2.3% contrasted with 2.9% in the previous year. Exports grew by 2.0% (4.6%) in 2018. While exports to the United Kingdom and Russia were sharply lower, there was a strong surge in goods shipped to the United States and China. The increase in imports was also slower at 3.3%, compared with 4.8% in the previous year.
The jobless rate in 2018 fell to 5.2% (5.7%) and continues to trend lower. The number of persons employed domestically rose by more than 565,000. Consumer prices rose by an average of 1.9% (1.8%) over the year.
Expansion in Asia remained brisk in 2018 at 6.6% (6.5%), although in China the rate of growth slowed slightly by 0.2 percentage points to 6.6%. The flattening in the pace of expansion is in line with the country’s goals: it is evident that the government is charting a more socially and environmentally sustainable path towards economic development. At the same time, it is making every effort to reduce the substantial risks posed by the recent sharp rise in debt levels, among other things by curbing bank lending.
Gross domestic product in Japan increased by 0.8% year-on-year, a slower pace than in the previous year (1.9%). Both domestic consumption and exports contracted; capital spending was also sharply lower year-on-year. While business investment was still close to the growth rate recorded in the previous year, investment in housing and public-sector spending slumped heavily.
The investment climate proved to be highly volatile and challenging in the period under review owing to numerous geopolitical and economic policy issues. Among other things, the threat and initiation of tariff and trade disputes as well as the ongoing uncertainty surrounding the outcome of Brexit negotiations were unsettling factors. All in all, the extent to which financial markets were influenced by political events was striking. Concerns about Italy’s stability also resurfaced, adding to the unease felt by market players.
Factors such as the overhaul of international trade agreements and the troubled waters in which the German government was operating initially had little effect on financial markets, which opened the year in astonishingly robust shape. On US markets hope of real growth stimuli from the Trump administration materialised at the start of the year in the shape of large-scale tax reform. Some emerging economies found themselves in funding difficulties as a consequence of higher interest rates in the US and saw their currencies depreciate as investors withdrew their funds. Hannover Re has so far remained unaffected by the crises in Turkey and Argentina because it does not hold any direct investments in the currency of either country.
The pace of China’s growth, on the other hand, continues to dominate the increasingly important role played by emerging markets in recent years. The consistent worldwide expansion that was still evident in 2017 thus gave way to a more nuanced picture in 2018. While US economic growth accelerated sharply and China also ended the year with better-than-expected GDP growth, central banks in some emerging economies were compelled to adopt a significantly tighter monetary policy in order to protect their currencies. This led to an appreciable softening in the pace of growth. The resulting decline in demand from emerging markets was in turn also a reason for softer growth in the Eurozone.
In mid-December the European Central Bank announced that after almost four years it would be terminating its programme of corporate sector purchases at the end of the year. It did so despite the fact that in light of global political tensions and moves towards economic isolationism the ECB’s assessment of economic prospects was less favourable than at the start of the year. Yet there are also no plans for an abrupt end to the anti-crisis mode, since the ending of bond purchases only applies to the investment of new funds. Funds from maturing government and corporate bonds will continue to be reinvested. All in all, the policy pursued by central banks in our main currency areas was inconsistent. The ECB left the key interest rate for the Eurozone at a historically low 0.0%, while the Bank of England, which had raised the prime rate for pound sterling for the first time since 2007 to 0.5% in 2017, made another modest hike in the year under review to 0.75%. Once again, the US Federal Reserve moved much further along the path towards normalisation of monetary policy, raising the base rate for the US dollar in four increments to an average of 2.38% and thereby further widening the interest differential between the US dollar area and the Eurozone.
Sluggish progress towards reaching a deal between the European Union and the United Kingdom as a consequence of the British people’s vote in favour of Brexit led to continued uncertainty throughout 2018. In the year under review this manifested itself in renewed modest losses for pound sterling against the euro and US dollar as well as in the downturn on UK stock markets. The protracted lack of clarity surrounding the definitive shape of future economic and trade relations between the EU and UK as well as regarding freedom of movement for workers is, however, also generally detrimental to the national economies of the remaining EU member states since it impacts planning reliability and the readiness of companies to invest.
Bond markets continued to be shaped in part by a generally low level of interest rates. An exception here was once again the US dollar area, which recorded further appreciable rate increases. Pound sterling bonds similarly saw rate rises, although they were limited to the short and medium maturity segments. Yields on euro bonds, however, which had already started the year on a low level, even experienced further declines in the medium and long maturity segments. As a result, negative returns persisted well into the medium maturity range. Risk premiums on European and US corporate bonds rose – in some instances markedly – in the period under review in virtually all rating classes. For the most part, the risk premiums are still very low by historical standards owing to the declines of recent years.
On equity markets the expectation of higher interest rates in response to an anticipated pick-up in inflation was reflected in the first quarter in corrections and sharply elevated volatility around the world. By the middle of the year things appeared to have settled back onto a calmer footing, only for the pent-up unease to flare up again on the markets – especially in the fourth quarter – with sometimes appreciable price corrections. Although the US market escaped relatively unscathed, it posted its poorest annual performance since 2008. European equities and the emerging markets sector came under even heavier pressure. European stock markets were still influenced primarily by the ECB’s ongoing expansionary monetary policy, although by year-end they were already reflecting the scaling back of bond purchases as well as comments by the President of the ECB to the effect that he anticipated a relatively vigorous surge in inflation. The stock market turmoil had scarcely any repercussions on other markets.
The euro gave back some of the previous year’s gains against the US dollar in the course of the year and fell from USD 1.20 to USD 1.15. Having already suffered heavy losses in the previous two years as a consequence of the Brexit vote, pound sterling again slipped slightly lower against the euro from GBP 0.89 to GBP 0.90. The Australian dollar similarly softened against the euro from AUD 1.53 to AUD 1.62.
The development of the world economy remains subject to various uncertainties and risks, first and foremost of a geopolitical nature or in connection with trade policy. Varying economic trends, isolationist efforts and local flashpoints may be mentioned here as factors driving the mixed global picture. A close eye must also be kept on the policy pursued by central banks as they seek to strike a delicate balance between showing resolve and a readiness to act, on the one hand, without unsettling financial markets through overly bold actions, on the other.
For more detailed remarks on the development of Hannover Re’s investments please see the "Investments" section.