Invesco’s Paul Jackson: The economic and market consequences of war

Paul Jackson, Global Head of Asset Allocation Research, Invesco

We analyse four potential ways in which the invasion of Ukraine could impact the global economy and financial markets: first, reduced exports to Russia, Ukraine and Belarus; second, a reduced flow of energy imports from Russia; third, higher energy prices and inflation; fourth, the potential impact on fiscal and monetary policies.

Russia’s invasion of Ukraine will bring severe economic consequences for both countries, along with Belarus. Despite only accounting for 2.1% of global GDP in 2020, the economic ripples from these three countries could have important consequences for the rest of the world.

First, via the usual trade effects – exports to these three countries add up to around 0.5% of the GDP of the rest of the world. Of course, it is neighbouring countries that are most likely to be impacted, with Baltic states among them (see chart below).

Second, Russia is a major supplier of energy to the rest of the world, especially Europe (Russia accounted for 65% of Germany’s pipeline gas imports in 2020, for example). Closure of those oil and gas feeds could have extreme short-term consequences for Europe, until supplies could be switched from elsewhere.

Even without that disruption, we reckon that a $10 per barrel increase in the price of oil would increase the world’s oil bill by around 0.4% of GDP (we think a similar effect would come from a 10% rise in the price of gas). Assuming that energy consumers would cut spending on other goods and services faster than energy producers would increase them, this suggests a negative effect on the global economy.

Finally, higher energy prices are adding to overall inflation and we can already see the effect on real disposable incomes and consumer spending volumes (we show the example of the US). This could turn into a positive if the Fed and other central banks are persuaded to delay rate hikes (though Fed Funds futures still point to six rate hikes this year).

However, the most concrete policy support is likely to come from governments with a widening of fiscal deficits. There is already a lot of military, medical and humanitarian aid being sent by NATO/Western governments to Ukraine, along with the deployment of NATO troops to Russia’s neighbours. We suspect this invasion of Ukraine will also lead to a permanent increase in military spending by European countries. Indeed, Germany announced that it will now boost military spending to above 2% of GDP from the pre-pandemic baseline of 1.1%-1.2%. As we outline, Germany is not alone in needing to make a big effort to meet that 2% NATO commitment.

Taking all of the above into account, and assuming no rapid resolution to this conflict, we fear that global GDP could be reduced by 0.5%-1.0%. That’s enough to aggravate the ongoing slowdown but not enough to produce recession. Nevertheless, some parts of Europe could experience recession, especially if there is a halt to energy flows from Russia. We also think that inflation will stay higher for longer, which will make life more difficult for central bankers. Nevertheless, we think markets are now overly aggressive in their views about the extent of rate hikes this year.

Unless stated otherwise, all data as of 25 February 2022.

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