The stand-off between the west and Russia over Ukraine intensified further this week. The US and UK announced an oil-embargo toward Russia. Russia retaliated by banning exports of telecoms, medical, vehicle, agricultural, and electrical equipment, as well as some forestry products such as timber. The end-game for the conflict is highly uncertain, but our base-case is that some level of conflict is likely to remain in Ukraine despite a potential truce, and uncertainty will prevail, but the war will not spread to other countries in Europe. In any case, we do not expect sanctions against Russia to be removed any time soon (for more details on our updated scenarios see here).
The war in Ukraine has led to huge swings in commodity prices. Brent oil briefly hit USD130 this week before falling back to USD109, as both Middle Eastern producers pointed to a possible rise in output amid the higher oil prices and Russian president Putin said Russia would stand-by its oil contracts with even “un-friendly” countries. Similarly the spike in European natural gas prices to EUR335 MWh at the start of the week reversed to EUR140 at the end of the week. The EU outlined a plan to reduce dependence on Russian gas by two-thirds this year, which seeks to tap new supplies and rely on efficiency gains.
The crisis and higher commodity prices have raised concerns about the global economic outlook, especially in Europe, which has closer economic ties to Russia. At its meeting this week, the ECB lowered its GDP forecast for 2022 to 3.7% from 4.2%. We share the view about headwinds to growth, which raises the risk of a global recession (read more in Research Global – Rising recession risk as yet another supply shock hits, 9 March).
The higher commodity prices put central banks in a tight spot. The ECB this week was no exception. Inflation was already high going into the crisis. Despite the possible hit to economic activity from the war in Ukraine, ECB decided to announce an end to its APP programme in Q3 and removed the “or lower” from its forward guidance. Going forward ECB will stay data dependent (especially regarding inflation prints), with optionality and flexibility in its monetary policy calibration, as all meetings from here will be ‘live’.
The mood in financial markets followed the swings in commodity prices closely. At the beginning of the week, risk sentiment took a big hit but sentiment later recovered with the fall in commodity prices. The EUR/USD also went on a rollercoaster, dropping sharply in the beginning of the week, but recovered along with global risk sentiment, ECBs mild hawkish signals and drop in commodity prices.
Next week, the Fed meeting will be the key focus for financial markets. We expect it to raise its policy rate by 25 bps given the strong inflation pressures, which are likely to be further enhanced by the rise in oil prices. We had previously expected a 50 bps hike, but the uncertainty from the war in Ukraine will make the Fed a tad more cautious in our view. BOE is similarly expected to raise its policy rate by 25bps next week. In contrast, the Chinese central bank is expected to lower its policy rate amid economic weakness. Other things in focus are war developments in Ukraine and response in commodity prices. In Germany, the ZEW will give a glimpse on the economic hit to confidence from the Ukraine-Russia war and we will likely see a marked dip.
