“Interest rates will not rise appreciably in the near future,” says Michael Menhart, Chief Economist at Munich Re. The change of leadership at the ECB will also make no difference in this respect. In addition, he is concerned about the growing risk for financial stability resulting from persistently low interest rates.
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Christine Lagarde takes over as President of the ECB from Mario Draghi in November. Do you expect the handover to herald a new direction for monetary policy?
Michael Menhart: I do not expect monetary policy to change direction in the immediate future. It is the macroeconomic conditions that are crucial, and there are no indications of change here – certainly not in the direction of higher policy rates. But things are not likely to stay the same: Christine Lagarde must – and also wants – to seek greater unity in the
ECB Governing Council. Recently there has been clear and open opposition to Mario Draghi from several Council members, who have called for a fundamental change of direction in monetary policy. She also could initiate checks on the inflation target to see whether it is still appropriate. Central banks are already in deep discussions about this. Christine Lagarde could also use the reputation she gained during her stint at the IMF to promote a more balanced policy mix among the governments of the eurozone. Such recommendations would include pursuing structural reforms as well as using leeway in fiscal policy. The latter might be directed at Germany. An improved policy mix could help to reduce dependence on monetary policy.
The economy is weakening, with the ECB's deposit interest rate at minus 0.5%.
Is there any leeway at all in monetary policy?
Menhart: The outlook for 2020 is not particularly rosy. The global economic environment and political uncertainties – most notably trade conflicts – are weighing on the economy in the eurozone, especially in Germany. The probability that it will turn out worse than expected is greater than there being a positive surprise. If the economy weakens further, the ECB will come under pressure to act, but additional interest rate cuts and bond purchase programmes are already having very little effect. The ECB is stuck in a central dilemma. Of course, in theory a central bank can also take more unconventional measures – such as the use of ‘helicopter money’ where money is ‘donated’ directly to citizens. But this would likely exacerbate the undesirable side effects of monetary policy and the problems of public acceptance.
Will interest rates rise again, at least in the long term? Or are we heading towards a Japanese situation?
Menhart: As long as there is no improvement in the economic outlook, there is little hope of higher bond yields. Even when growth was stronger in recent years, the expectations of many economists of a normalisation of the interest-rate environment have not been fulfilled. There is increasingly talk of a threat of ‘Japanification’. As is well known, Japan has had very low interest rates for a long time, with weak growth and very low – at times negative – inflation rates. Such a scenario is more relevant for the eurozone, less so for the USA. But a comparison between Europe and Japan must also be differentiated. It is true that an ageing society and current low productivity growth indicate only moderate growth in the long term. That is not unlike Japan. But it is also true that both the trigger for the long-standing ‘malaise’ in Japan – the bursting of a large asset price bubble in the 1990s – and the economic policy reaction there differ from the situation in Europe. And finally, since the early 1980s, we have been witnessing a global trend of falling nominal and real interest rates. The underlying global factors – in particular demographic developments, lower increases in productivity and strong savings accumulation in emerging markets – are at least as important as the respective conditions in an individual country. No central bank can change any of these factors. Otherwise, interest rates would have to be significantly higher in countries like Australia that have clearly better macroeconomic and demographic conditions than the eurozone.
So there is no light at the end of the tunnel?
Menhart: A central bank that continues to buy bonds, and having a weakening economy, make the eurozone particularly vulnerable to a scenario of persistently low interest rates similar to that in Japan. But in other industrialised countries, too, the indications are for ‘lower for longer’ – including for inflation. However, three scenarios could lead to a significant rise in interest rates in the longer term: firstly, a noticeable return of inflation; secondly, a more expansionary fiscal policy – for example, in countries such as Germany; and thirdly, higher economic growth. Insurers should not hope for the first, while the second is a quite controversial policy recommendation – but which makes sense if there were higher public investment spending in infrastructure, for example. That would then be an important contribution to more growth in the long term.
What does this outlook mean for the insurance industry and for Munich Re?
Menhart: Persistently low interest rates ensure that the ‘hunt for yield’ on the financial markets continues, and that the danger of an overvaluation of asset prices rises. The International Monetary Fund, for example, is warning of risks to financial stability – not only because of possible asset price bubbles, but also because in many countries there has been a significant rise in corporate indebtedness, in particular. This is a dangerous side effect of central bank policy in recent years.
In reinsurance, a persistently low interest rate environment has an effect above all on
long-tail business, as interest income contributes less to earnings. There is some relief from the expectation of low inflation, at least in those segments in which profitability depends on economic inflation factors. And life insurance business shows how important it was to no longer rely on products with interest rate guarantees.
Head of Economics, Sustainability and Public Affairs