Russia-Ukraine War could slow global growth

Putnam Fixed Income team, 03/15/22


  • Energy and commodity prices are expected to remain elevated for some time before stabilizing.
  • Central banks will weigh the effects of war, sanctions, and inflation to determine policy paths in 2022.
  • Global economic growth will likely dip over the next few quarters as energy prices and interest rates rise.

Russia’s invasion of Ukraine has created high levels of uncertainty in the global economy. The war and widespread sanctions will likely have a knock-on effect on economic growth, inflation, interest-rate policies, and the future of renewable energy. We analyze the fluidity of recent events and their economic implications in this post.

Europe’s reliance on Russian energy

The United States and European countries have imposed multiple rounds of sanctions on Russia, including some restrictions on Russian banks. The economic sanctions will hurt Russia’s economy but are not likely to deter President Vladimir Putin’s government. Russia is a major commodity exporter of products including oil, natural gas, wheat, and base metals. Countries such as Russia and Iran do not typically abandon their ideology because of economic hardships triggered by sanctions. They have historically proved to be stubborn and resilient. Their economies fall into recessions and, eventually, adapt to these changes. Disruptions to energy supplies will directly impact oil and gas importers, mainly Europe. Russia supplies about a third of the region’s energy needs; almost 50% of Germany’s and 25% of France’s energy imports come from Russia. There is a possibility that Russia would cut off energy supplies in response to the sanctions or that the new set of sanctions include Russia energy. The worldwide energy supply was in a structural deficit before the Russia-Ukraine War given strong demand levels. Any disruptions can have dire consequences for a commodity that has inelastic demand in the short term. We believe oil markets will price in the possibility of a worsening war in Ukraine and further supply disruptions. Since the conflict is not likely to de-escalate any time soon — and could continue to simmer in the background — prices of oil and other commodities will likely remain elevated and can rise further. For more on our views on oil, see Oil prices may correct after sanctions-related spike.

ECB rates hikes are not a “zero” probability

The policies of central banks and governments will determine whether high energy prices lead to a sustained period of high inflation. In late 2021, several European governments announced subsidy programs and cuts in value-added taxes on gas and electricity bills due to skyrocketing energy prices. Now, many more European countries are stepping in with a mixture of price caps, tax cuts, and subsidies. Such measures could extend the duration of high prices and inflation as company and household balance sheets are in a relatively healthy state.

The European Central Bank (ECB) recently tempered its hawkish pivot on interest rates. The ECB will continue to wind down its asset purchase program over the near term. But policy normalization could be limited as signs of a slowdown emerge toward the end of 2022, in our view. The ECB could refrain from hiking its policy rate this year, but that is not a zero probability. Some members of the central bank’s governing council have signaled they would like to move away from a negative-interest-rate policy.

In the United States, the Federal Reserve has signaled it will raise interest rates several times this year and start the balance sheet runoff. Still, rising concerns about growth are likely to deter the Fed from accelerating the pace of tightening later in 2022, reducing the probability of an aggressive rate hike cycle.

Renewable energy in the cards

The Russian-Ukraine conflict could accelerate the pace of transition to renewable energy in the medium to longer term. European countries have ambitious carbon reduction plans, and the conflict may help facilitate the shift. In late February, German Chancellor Olaf Scholz halted the certification of the Nord Stream 2 gas pipeline designed to bring natural gas from Russia directly to Europe. Germany’s coalition government includes the Green Party, an environmentally focused political party.

In the United States, plans for a transition to using renewable energy are not as advanced as in Europe. But President Joe Biden’s administration has several items, such as harnessing power from wind and new solar projects, on its clean-energy agenda. An accelerated transition toward renewable and green energy could translate to higher conventional energy prices.

Finding equilibrium amid the conflict

All in all, energy and other commodity prices are likely to remain elevated over the short to medium term. But we expect prices to eventually stabilize. A resolution to near-term issues such as the energy supply squeeze and the conflict in Ukraine could bring about a downward move in oil prices, in our view.

Natural gas and wheat prices have spiked since the start of the Russia-Ukraine War

Source: Bloomberg, as of March 11, 2022.

Against the current backdrop, central banks may reconsider their policy options, including raising interest rates. Policymakers may respond to high inflation but with an eye on growth and recession risks. In our opinion, inflation will decline — gradually — to targeted levels. Global economic growth will slow over the next few quarters because of higher energy prices and rising interest rates, in our view. Therefore, this transition period can qualify as stagflation. Stagflation is not static and is unlikely to persist. But we think inflation and the risk of slow growth will be around long enough to keep the stagflation narrative alive.

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