How Russia’s Invasion of Ukraine Will Hit the Global Economy

A conflict that could become Europe’s biggest since World War II has dashed hopes of a strong global economic recovery after the coronavirus, at least in the short term.
Russia’s invasion of Ukraine on Thursday rocked financial markets, and rising geopolitical tensions are likely to exacerbate already high inflation and supply chain bottlenecks.

The direct impacts of lower trade with Russia, economic sanctions imposed on Moscow by the United States and the European Union, and financial contagion are likely to outweigh the indirect consequences on business and consumer confidence and commodity markets, in the opinion of economists.

These repercussions can range from relatively limited to extremely serious. If energy prices continue to rise, for example, they could easily push the global economy into a second recession in three years.

Economists said the following issues are the main ones to watch out for.

How serious will the war be?

The ultimate goal desired by Russian President Vladimir Putin is unclear. Analysts are considering various scenarios ranging from a change of government in Kiev to a Moscow-friendly regime to a widespread attempt to redraw Europe’s borders, and more.

Holger Schmieding, chief economist at Berenberg Bank, said the first thing to consider is “how serious will the war be?” —which would determine the likely response of the financial and energy markets in the coming days.

The broader global reaction will be just as crucial, other economists said. Tim Ash of BlueBay Asset Management highlighted China, which signaled its willingness to help Russia manage the financial consequences of its military actions.

Beijing’s response would be vital in terms of broader consequences, which could range from malign — for example, greater strain in its own relationship with Taiwan — to more beneficial diplomatic outcomes.

“Or [a China] sees it as an opportunity to enter Taiwan or an opportunity to improve relations with the US,” Ash said.

Are the markets able to withstand the geopolitical shock?

Major global financial markets fell sharply on Thursday, but the result could have been more radical, suggesting they were surprised by Putin’s actions but still don’t believe in the likelihood of more severe market shocks akin to a financial crisis. This leaves open the possibility that markets will have to fall further, with consequences for corporate and household wealth, consumption and global confidence.

Neil Shearing, chief economist at Capital Economics, noted that while there has been a sell-off in equities, bond yields have fallen and credit spreads have not widened by much, suggesting that the market reaction was orderly and does not yet indicate expectations of an wider war across Europe.

Preventing a market crash was not global, and many emerging economies were hit by much sharper swings. Kevin Daly, portfolio manager at Aberdeen Asset Management, noted strong sales in Ghana, Turkey, Egypt and Pakistan, citing a flight to safety from financially vulnerable countries.

Randy Kroszner, vice dean of the Booth School of Management at the University of Chicago and former governor of the Federal Reserve, said recession risks would appear in the difference in yields on investment-grade debt compared to non-investment-grade debt, which did not broaden widely on Thursday.

He added that sovereign debt yields from countries geographically close to the crisis can provide a good indicator of whether markets have begun to fear a wider conflict.

To what extent can trust be reached?

It will be crucial for the global economy if households and businesses become significantly more cautious, spending less and saving more in response to Russia’s actions.

Ian Shepherdson, chief economist at Pantheon Macroeconomics, said slower growth was inevitable. “Consumer sentiment everywhere will weaken further. (…) This should mean slower economic growth than would be expected in Europe, the US and most emerging markets,” he added.

Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, said: “Depending on how long this crisis continues, there could be a significant loss of trust between businesses and consumers.”

Economists have also warned of pressures on companies exposed to supply chains in which Russia plays a crucial but little-known role, such as the production of critical raw materials. The country supplies about 40% of the world’s palladium, a key component of catalytic converters in gasoline-powered vehicles, as well as electronic devices.

How do energy concerns affect the bigger picture of inflation?

Europe is highly dependent on gas from Russia and will not be able to find alternative supplies quickly if pipelines are cut. With a mild winter coming to an end and inventories across Europe higher than expected by some industry analysts, the gas supply issue has become less acute but will return later in the year if the crisis continues.

The most immediate concern is the impact of the crisis on the price of oil, gas and other commodities. A sharp rise would raise inflation and hit consumers.

“Our modeling suggests that in a worst-case scenario, oil prices could rise to $120-$140 a barrel,” said Shearing of Capital Economics. “If it’s held for the rest of this year, and we have a corresponding rise in European natural gas prices, that would add about two percentage points to advanced economy inflation — more in Europe, less in the US. That’s a further squeeze on real income.” .”

Pantheon’s Shepherdson said the US will be relatively isolated in general, although the continued rise in prices # hits shale oil and gas producers but hits the pockets of American consumers.

This could reinforce pressure on central banks to raise interest rates. The US Federal Reserve already signaled last month that it would start raising rates from March to rein in runaway inflation. In January, Fed Chair Jay Powell declined to say how many rate hikes there will be this year.

Krishna Guha, vice president of Evercore ISI, said the invasion in Ukraine “complicates the ability of central banks on both sides of the Atlantic to project a soft landing after the outbreak of pandemic inflation”, and expects financial markets to reduce expectations that central banks will raise interest rates.

Translated by Luiz Roberto M. Gonçalves