Ukraine’s Fog of War Reaches Central Banks
While the direct spillovers from Russia’s invasion for the broader European economy are few, the jump in energy prices is causing markets to fret about stagflation
By Jon Sindreu
Russia fulfills 40% and 30% of the EU’s demand for natural gas and oil, respectively./ PHOTO: ANTON VAGANOV/REUTERSRussia and Ukraine may not have strong ties to the global economy, but investors are already betting that a disruption in energy supplies will result in higher inflation, weaker growth and a devilishly difficult task for central banks.
On Thursday, Russia launched a military attack on Ukraine after weeks of tension, throwing financial markets into a tailspin.
Ukraine suspended currency and equity trading, and Russia’s MOEX stock index plummeted by more than 30% after a few hours of exceptional closure.
The aftershocks rippled through European, Asian and U.S. equity markets.
European corporate bonds sold off too.
Among the biggest fallers on Western exchanges, the London-listed shares of Hungarian low-cost airline Wizz Air lost 14% after being forced to halt flights to Ukraine.
Renault stock fell 11% because the French auto maker has a controlling stake in Russia’s largest car manufacturer AvtoVAZ, making it a potential victim of further sanctions imposed by the U.S. and its allies.
British defense contractor BAE Systems was one of the few in the green, due to forecast-beating fourth-quarter results and the expectation of higher military spending in Europe.
More broadly, investors sought protection from the increased risk that the war will simultaneously stoke inflation further and depress economic growth—the dreaded “stagflation” of the 1970s.
Within the Stoxx Europe 600, which fell roughly 4% Thursday, “cyclical” industries that typically move in lockstep with economic booms and busts were by far the most affected: Banks and auto makers lost 8% and 7%, respectively, whereas “defensive” sectors like healthcare and utilities did much better than average.
This could be seen as a knee-jerk reaction.
After all, neither Russia nor Ukraine play a significant part in global trade links and, barring some exceptions like Renault, Western companies don’t have substantial assets in the region.
This makes big spillovers into corporate earnings unlikely.
But one factor could have outsize short-term impacts: Russia fulfills 40% and 30% of the European Union’s demand for natural gas and oil, respectively.
Energy shortages already pushed eurozone inflation to a record 5.1% in January.
Crude prices are now above $100 a barrel and gas futures rose 40% Thursday.
Bond markets show the conundrum for policy makers.
Market expectations of average eurozone inflation a year from now jumped to 3.5% Thursday, from 2.6% before tensions in Ukraine ramped up two weeks ago, as investors rushed to buy inflation-protected debt.
Yields on one-month German bills have gone up, probably reflecting a greater chance that the European Central Bank will soon tighten policy.
However, yields for paper maturing a year or more in the future have sunk, particularly at the five-year mark.
This reflects demand for safe-haven assets—traders also bid up the price of gold—as well as fears that even higher energy bills will depress spending by Europe’s lower-income households and lead to weaker economic growth.
Unlike in the U.S., eurozone wage growth has been tepid.
Of course, this also would seem to preclude the type of wage-push inflation that caused stagflation in the 1970s.
Indeed, 10-year inflation expectations have increased only slightly, and the post-pandemic recovery appears robust.
Yet central bankers have spent the past few months emphasizing that even commodity-led inflation can warrant tighter monetary policy.
They have put themselves in an uncomfortable position because by this logic the Ukrainian situation warrants earlier tightening, when it might otherwise be another reason to further support the economy.
The latest statements by ECB officials at least seem to suggest a big “front-loaded” surprise is unlikely come March’s policy meeting, and that they will seek to keep their options as open as possible.
As if divining where interest rates will go wasn’t hard enough already, it is now further obscured by the fog of war.
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