The biggest cost of Vladimir Putin’s war in Ukraine is human – and we send our deepest sympathy to all of those caught up in this tragic conflict. However, the Russian leader’s recent actions have some significant economic costs too – and the market implications are significant and long lasting.
It is possible to look at the wider implications for the rest of the world now we have a clearer idea of the nature of the war – and of the rest of the world’s response.
Russia’s invasion of Ukraine will:
- Mean higher inflation for longer
- Lower growth in leading economies
- Prolong and worsens supply-chain interruptions created by the pandemic
- Create shortages and price spikes in energy and food
- Boost defence spending, led by a significant shift in German policy
- Accentuate policies to increase national resilience and domestic production
- Lead to a rethink of net-zero policies, with acceleration in the plans for more renewables
- A greater use of other fossil fuels in the short term, as countries look for substitutes for Russian gas
The cost-of-living squeeze on both sides of the Atlantic has just got worse. The most worrying fear for markets has been the possibility that the post-Covid surge in prices embeds through rising wage demands. Otherwise, many expected a short, sharp rise and then fall in prices as supply chains bounced back from the pandemic lockdowns.
Now, forecasters need to factor in prices going even higher in the short term and staying there for longer. Oil and gas prices have risen steeply. Grains are now also under upwards pressure for fear of interruptions to Ukrainian and Russian supply. The spending power of many people and households will be cut further by the need to pay more for the basics, curtailing discretionary demand.
This poses a big problem for central banks, which are attempting to catch up with events after misjudging the scale of inflation last year. The inflation numbers will give them more reason to raise rates and cut the size of their balance sheets, yet the slowing effect of this fall in real incomes on output and growth should lead them to be cautious. We will watch each of them – expecting some compromise between the two positions.
Major trade implications
The supply-chain disruptions will occur both because more countries and people will shun Russian goods and because the war itself may cut the output of Ukraine and Russia for export. The use of wide-ranging sanctions is leading many companies to abandon or temporarily close Russian facilities and investments.
Export bans into Russia will force Russia to work with China, Pakistan and other friendly powers.
The European Union (EU) will examine how quickly it can wean itself off Russian energy imports. Export bans into Russia will force Russia to work with China, Pakistan and other friendly powers to find alternative trading systems to its old western patterns. Some shipping will be disrupted both by bans on Russian ships and by the impact of the war zone on the Black Sea area. The next Ukrainian harvest may be damaged by the war. Russia, so far, has wanted to maintain its exports to maintain flows of foreign currency, but could consider further action restricting exports of key items to increase pressure on the West.
NATO has been alerted to new dangers and threats and will doubtless now have an easier task persuading member states to increase their defence spending. It should also move the alliance to consider access to necessary raw materials and technologies in a world where China has been acquiring a lot of economic control through its Belt and Road initiative.
As we have frequently noted, the world was in a retreat from high globalisation before Covid-19 emerged or Vladimir Putin launched a war in Europe. Former President Donald Trump's opening salvoes of a trade war with China signalled the wish of the US to depend less on Chinese imports. This led to pressure on US allies to drop Chinese technology from their computer, phone and military systems.
This war will speed up and intensify work to create greater national resilience.
President Joe Biden has continued this approach. Mr Trump’s “Make America Great Again” has morphed into Mr Biden’s “Made in America”. The Europeans too are considering how they can be more self-reliant in energy and technology. This war will speed up and intensify work to create greater national resilience in major countries. It will mean therefore more taxes, bans, subsidies and trade restrictions.
Mr Putin has also sown confusion into the heart of net-zero policies. A short time after the EU had concluded that gas was a necessary transition fuel – and that it would help get out of coal quickly – the gas tap from Russia becomes suspect. The rapid rethink now underway is likely to sanction more coal for longer, reprieve some nuclear power stations and redouble efforts to have more renewables in due course.
All this amounts to a lot of changes in priorities and valuations of assets. So far, the market has concentrated on heavy mark downs of all Russian assets, and upward valuation of fossil fuels which will be around for a bit longer at higher prices.
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