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How events in Ukraine change our economic views

Higher oil prices resulting from events in Ukraine are likely to trim economic growth and accelerate inflation to levels beyond what was previously expected.

The initial impact on the global economy from the tragic events in Ukraine will be delivered primarily through higher commodity prices, according to a new analysis by Vanguard’s global economics team. The higher prices, most notably for energy, will hamper growth and cause broader prices to climb further than previously expected, according to the analysis.

Tighter financial conditions, diminished consumer and business confidence, and elevated uncertainty will also have an effect, though to a lesser extent. The economic impact is likely to be more profound in the euro area, given its greater dependence on Russian energy, than in the United States or the United Kingdom.

Persistently higher energy prices and tighter financial conditions could shave up to a percentage point from previously anticipated 2022 growth for the euro area, the United Kingdom, and the United States. Meanwhile, inflation, as measured by headline consumer price indexes, could accelerate by 1 to 3 percentage points above what Vanguard had previously forecast.

Investors need to appreciate the tremendous uncertainty confronting markets, said Shaan Raithatha, a London-based Vanguard senior economist, part of the team researching possible effects from a range of potential developments. He emphasised, “The work we’re doing is based on conditions at present, and the situation is clearly fast-moving.”

Rising energy prices likely to weigh on growth and generate higher inflation

energy prices

Notes: Prices are daily settlement prices for front-month Brent crude futures traded on the Intercontinental Exchange in London and for front-month West Texas Intermediate crude futures traded on the New York Mercantile Exchange.

Sources: Vanguard illustration, using data from Bloomberg as of March 2, 2022.

Prices of benchmark oil futures trading in both London and New York are up more than 45% since the start of the year and more than 20% since a week before Russia’s invasion of Ukraine, reflecting both oil’s greater perceived risk and concerns about restrictions on supply.

Persistent higher energy prices affect growth because consumers will have less to spend on other things. They also weigh on profit margins, leaving businesses less to reinvest.

How long high energy prices persist and to what degree will be vital to informing whether our views move from our baseline case to a downside of even slower growth and higher inflation. For conditions to deteriorate to the point of ushering in a recession, oil prices would need to climb to a range of $130 to $150 a barrel for several quarters and financial conditions would need to tighten broadly, according to the Vanguard economics team’s analysis. Vanguard foresees developed-market inflation averaging more than 8% for all of 2022 in such a case.

Growth and inflation effects would be felt more acutely in the euro area, which gets 40% of its natural gas and 25% of its oil from Russia, than in the United Kingdom or the United States which use much less Russian energy.

Central bank policy decisions hang in the balance

The developments in Ukraine present central banks with a pertinent challenge: Do they continue down the path toward tighter monetary policy to fight even higher inflation, or do they pause and take stock given the new risks to growth? Vanguard currently doesn’t expect recent developments to materially affect U.S. Federal Reserve and Bank of England policy stances. The Fed’s chair told Congress on March 2 that a hike in the federal funds rate target at the Fed’s March 16 meeting remained appropriate, though he did acknowledge concern over events unfolding in Ukraine.

The European Central Bank (ECB), meanwhile, meets sooner, on March 10. Vanguard hasn’t changed its expectation for a late-2022 ECB rate hike, though we’ll be watching developments closely. “Our view is that recent events and the accompanying uncertainty have the potential to make the ECB more cautious,” Raithatha said. “This will skew the balance of risks toward the Governing Council delaying its normalisation of monetary policy. The ECB will also stand ready to provide additional liquidity should the proper functioning of markets be impaired.”

If you are looking for financial advice in these gloomy economic times, please contact us today.

This article has been sourced from Vanguard.

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