Economic update: Weaker outlook resulting from the Ukraine crisis; increased risk of recession

Business surveys were generally stronger in February as Covid cases fell in many countries and Covid-related restrictions eased.

Supply chain problems also showed signs of easing a bit too, helping some of the manufacturing output indicators. However, given the rapid deterioration of the situation in Ukraine over the past couple of weeks or so, these business surveys feel dated.

Slower quarter-on-quarter rates of GDP growth already looked likely over much of 2022, beyond the economy bouncing at the start of the year post-omicron. Growth looked set to normalise somewhat; consumer spending growth already looked under pressure in the wake of high inflation; and the policy backdrop looked set to become less supportive (both fiscal and monetary). However, the risk of recessions in a number of economies has risen over the past couple of weeks, especially in Europe. That reflects, in particular, the threat to consumer spending posed by the impact of the Ukraine crisis on commodity prices and potential impacts on supply chains.

Business survey signals on price pressures in data over the past month were mixed but continued to point to substantial pipeline inflation pressure even before the Ukraine crisis. Corporate and household cash/deposit levels remain high in aggregate and can provide support to some households (though levels have already reduced in some places, including the euro area).

Despite the worse outlook for activity growth, it is difficult for some central banks to take a step back from monetary policy tightening paths given very high and rising inflation. The Bank of England is still expected to hike in March and the Federal Reserve continued to signal a March rate rise in the US. The European Central Bank (ECB) announced a faster pace of asset purchase tapering despite the Ukraine crisis (though they did make the expected span of time between ending asset purchases and starting rate rises more data rather than date dependent).

Wage pressures and longer-run survey-based inflation expectations look more contained in the euro area than in the US or UK, putting the ECB under somewhat less pressure to get actual policy tightening underway. The euro area economy also has significant linkages with both the Ukraine and Russia (notably including over 40% of EU natural gas imports coming from Russia according to 2019 data), suggesting bigger downside risks to the outlook for activity growth.

Pressure is likely to build for more cost-of-living support from fiscal policy which could help ease the impact of higher commodity prices on consumers this year. It wouldn’t be a surprise to see more measures announced in the UK in the March Budget. Bloomberg has reported that the EU is considering joint bond sales to fund energy and defence spending. In the US, pressure on cost of living – gasoline prices, for example, recently hit a record high in nominal terms – makes it conceivable that more support measures could emerge, though October’s mid-terms may make getting policy agreement politically difficult.

The situation in Ukraine adds substantial uncertainty to the economic outlook. The forecasts below show higher inflation in 2022 and lower GDP growth than on previously published forecasts. However, the degree of upside for inflation and downside for real activity are difficult to gauge reflecting the changing situation on the ground and the volatility of commodity markets and partly depend on the duration of the crisis.

For more on the Ukraine crisis and the risks to the outlook, see our Ukraine conflict markets update webinar.

Source: National Statistics offices, RLAM forecasts; January 2022 estimates in brackets. US policy rate shows upper bound of US Federal Reserve (Fed) Funds target range. Euro area shows refi rate

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