The war in Ukraine: from the European economic shock to the Russian crisis due to sanctions

The war in Ukraine

The economic derivative of the war in Ukraine is beginning to be felt in the economy and the markets. Equities link two weeks of high volatility, while commodity and energy prices soar. This scenario, one of the worst anticipated by experts from various entities, leaves the future of Europe’s economic recovery pending what happens to the east of the Old Continent, while many analysts agree that the crisis that will affect Russia will cause a sharp drop in its GDP.

“If the conflict continues, the sharp rise in energy prices and the sharp disruptions in supply chains will be a major drag on global economic activity and a big boost to inflation,” says Silvia Dall’Angelo, economist senior at Federated Hermes. She maintains that the sanctions against Russia leave Europe in a vulnerable situation due to its energy dependence.

On the other hand, ING experts believe that, in the short term, “disruptions in the supply of energy and raw materials will weigh on growth and push inflation higher for longer. Particularly in Europe, the risks of stagflation have increased.

“As the region closest to the conflict, Europe is the most unsettled from a market sentiment standpoint. We see a higher probability that a growth shock in the market (which had already increased due to supply chain disruptions and inflationary cost pressures)”, insists Chi Chan, portfolio manager of European equities. at Federated Hermes.

Due to the situation that will arise around the conflict, this expert maintains that the probability that interest rate rises will accelerate has lessened. In fact, Dall’Angelo argues that it is likely that “the political response is likely to be different on both sides of the Atlantic. European countries are likely to resort to some fiscal easing to cushion the blow of high energy prices to consumers while devoting more public spending to the refugee crisis and defense.”

An idea also defended from ING, which anticipates that at the next meeting of the European Central Bank (ECB) any indication of a rate hike is ruled out. “We hope you will avoid tying your hands in any direction; continues to announce a reduction, without ruling out a new relaxation of monetary policy if necessary”, they add.

However, Berenberg they are somewhat more optimistic since they believe that the fall in Russian income does not pose risks to the financial stability of the Old Continent. “As economists, we have to understand if sanctions could threaten the European boom. In our opinion, this seems unlikely.”

The Situation in Russia

A very different situation is the one that is beginning to be experienced in Russia. The numerous sanctions that the Western powers have carried out against the country are beginning to suffocate it both economically and financially. “The strong sanctions have triggered a very negative reaction in the Russian markets. Stocks, bonds and the ruble have plunged. Local reports of bank runs and some panic buying in the face of likely rising inflation suggest a crisis could be developing.

Meanwhile, Neil Esquileo, chief economist at Capital Economics, says the immediate effect of the war will be to push Russia down several places in the ranking of the world’s largest economies. “However, the long-term impact on the world economy will depend largely on its political and geopolitical legacy.”

This analyst believes that Russia’s GDP will fall several places in the world ranking, from being the 11th global economy to being ranked 14th, with 1.4 trillion dollars (compared to 1.65 trillion today).

On the other hand, the freezing of almost two-thirds of the assets of the Central Bank of Russia has drastically reduced the institution’s ability to stabilize the ruble through direct intervention in the foreign exchange markets, forcing it to raise interest rates up to 20 %, from 9.5%, and increase the supply of money and reserves to meet the growing demand for liquidity, according to Berenberg.

“Conditions in the Russian financial system and the broader economy are likely to deteriorate further in the coming days and weeks, as already announced sanctions take their toll and future ones add to the sustained negative impact. For the foreseeable future, Russia will remain isolated from the Western world and from major world markets.”

Esquileo, for his part, focuses on the fact that the situation in Ukraine and Russia is not the same as that of other eastern states, such as Poland, Hungary or the Czech Republic, because they are in the European manufacturing supply chain and have large inflows of foreign investment. “On the contrary, a combination of political, economic and historical factors has slowed down the market transition in Russia and Ukraine. Key problems include governance concerns and the lack of establishment of effective property rights. Natural resource rents have also hampered the development of a manufacturing base,” he adds.