Swiss Re estimates that in 2020 the non-life profitability gap was roughly 7–11% of premiums earned, due to the low-yield environment.
Over time, the company says, higher interest rates will be reflected in insurers running yield and interest income, helping to soften the profitability gap.
Swiss Re sees a seismic shift in global policymaking, saying one of the most significant monetary tightening cycles in decades is unambiguously under way. “Advanced economy central banks are finally closing the door on the ultra-low interest rate policies in place since the global financial crisis as they face down high inflation.”
The US Fed, the Swiss National Bank and the Bank of England have all recently tightened policies and the European Central Bank intends to follow suit shortly.
Swiss Re’s updated central bank policy forecasts reflect the urgency of interest rate hikes as inflation soars.
“We believe central banks will press ahead with policy tightening even as growth slows, until there is a significant decline in inflation momentum”
“Consensus will likely move higher as it doesn’t capture the recent policy developments yet. An aggressive new cycle of central bank tightening is needed. We expect inflation rates, especially in the euro area and in the US, to stay elevated for longer, suggesting inflation persistence that requires a forceful monetary response.”
While central banks are normalising policy quickly, they remain well behind the curve. Almost all major advanced economy central banks are at least 2 percentage points below interest rate levels that would be warranted given the current economic environment.
Swiss Re says that conditions today are the reverse of the last decade: central banks need to contain inflation rather than push it upward. This has fundamental and wide-ranging implications. A hallmark of post-global financial crisis monetary policy was a de facto competitive devaluation in currencies and an associated race to the bottom in yields through zero and negative interest rate policies as well as quantitative easing programmes.
Now the opposite may be playing out. So far most central banks appear unwilling to accept currency weakness, which adds to inflationary pressure. Since foreign exchange rates are also driven by interest rate differentials across economies, this implies a lower bar for central banks to enforce a tighter monetary stance.
Central banks may also need to accept higher financial market volatility as a result of higher interest rates and less capital market intervention.
