Ukraine and the impact on markets

7th March, 2022

The events in Ukraine have understandably destabilised markets as investors digest the prospect of war in Europe. Geopolitical horrors such as this one have usually seen a relatively short-lived impact, with markets recovering quickly after the initial shock. However, is it naïve to assume the same thing with a conflict of this magnitude?

The consensus appears to be that there will be some impact on economic growth as a result of the conflict. PGIM’s fixed income team puts this at around 0.5% for the Euro area, which will probably be the hardest hit region outside Russia and the Ukraine. The economic hit comes from higher energy prices, which will reduce the capacity of businesses and consumers to spend, while also hurting confidence and trade.

Some countries will be harder hit than others. Germany, for example, is uniquely reliant on Russia for its energy needs, while Italy looks vulnerable for the same reason. Areas such as the US and UK have far less reliance on Russian energy. But it is not only energy supplies, the Netherlands and Germany also export significant volumes of high tech manufacturing equipment to Russia, which is no longer possible given export bans. While the Russian economy isn’t large (smaller than Italy and Canada and sliding fast), it will still hurt some individual companies.

Rising energy prices will feed into higher inflation, so there is a question over whether central bankers will be forced to act and raise interest rates faster and more vigorously than previously expected. However, few expect them to take a hawkish tone. If anything, central banks may postpone interest rate rises to ease cost of living pressures.

Set against the pandemic, the economic toll of the Ukraine crisis seems relatively small, but it is not insignificant. Markets may be inclined to over-react, but there is an impact for companies and consumers. As such, some weakness in markets is justified, even if all the usual messages about not panic-selling still apply.

However, in the longer-term – and if policymakers are sensible – it should accelerate the move to a more sustainable energy infrastructure. For too long, Western countries have left themselves vulnerable to the caprices of dictators to shore up energy supplies. If Ukraine is the catalyst for them to realise this is unsustainable and to turn away from fossil fuels, Putin will only have himself to blame.

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