What's the likely economic impact of the Ukraine conflict?

The human impact of the Ukraine conflict is tragic and as yet unquantifiable, but as economists we’ve tried to get a handle on the economic impact.

We think events of last Thursday are taking the global economy in a more stagflationary direction. We’re adjusting upwards our forecast for inflation, while taking our forecast for growth downwards.

We expect Europe to be the region that takes the biggest hit to both growth and inflation. Globally the effects are likely to be less substantial as we were heading in a stagflationary direction anyway, given that the tightness of supply chains and labour markets is worse than expected.

We think US will have slightly higher inflation than we previously forecast, but is less affected by events in the Ukraine. So too China and emerging markets, though clearly if we have slightly slower economic growth than forecast, these markets will be impacted.

Turning to central banks, I think the Federal Reserve (Fed) will be more gradual now in its monetary tightening. I still expect it to raise rates in March, though perhaps only by 25 basis points. I expect four rate rises from the Fed this year now, rather than the five I was forecasting previously. Then it will likely to continue slowly tightening in 2023.

The European Central Bank (ECB) is a different matter, because Europe is worse affected by the Ukraine conflict. We were already expecting the ECB to be more dovish than the consensus, which was predicting two rate hikes this year. Last week’s events have reinforced our conviction that the ECB won’t raise rates this year and will continue QE. There will probably be a rate rise in the second half of 2023.

To make these forecasts we’ve had to work out an assumption of how the Ukraine situation plays out. We’ve felt it best to assume that Russia takes over the Ukraine and controls it in a similar way to Belarus, with essentially a puppet government. The impact of this would be a degree of stabilisation, but it will be a little like the Cold War, with NATO forced to secure its borders, given that NATO members such as Romania, Poland and Slovakia surround the Ukraine.

Of course, much depends on the extent to which the West becomes involved militarily and whether we see a serious and more prolonged escalation in the conflict. It is hard to see where such a scenario could end.