As anticipated, the Russian invasion of Ukraine has led us to lower Oxford Economics forecasts for European countries. The speed at which events are unfolding means that uncertainty remains extremely high, with the volatility seen in European gas prices as a clear example.
Oxford Economics forecasts will see a combination of higher-for-longer inflation and lower growth, mainly via more subdued consumption. GDP growth for the eurozone will be close to 3% this year, but as the carry-over from last year is around 2% this is hardly a robust outturn.
The transmission channels of war to the economy
Moreover, Russia’s invasion of Ukraine also means that more negative scenarios, such as the one presented here, are now plausible alternative scenarios.
In addition to the obvious cost in human lives, the impact of the events in Ukraine and Russia will be felt immediately in Europe. This will unfold through several channels: energy prices, trade, disruption in supply chains, financial market shocks and the impact on confidence.
The most visible channel so far is the impact that this conflict is having on prices. Price futures on gas, with Russia supplying around 40% of the EU’s total gas supply, almost doubled in two weeks. The revision to input prices, such as energy prices but also food prices, has prompted us to raise our inflation forecast, which we now see averaging around 5% for the eurozone in 2022. And while our new forecasts for gas were raised sharply, the reaction in financial markets suggests that risks are clearly skewed towards a further upward revision.
Figure 1 Revised growth forecasts in the Eurozone, 2022-24
Inflation on the rise again
Moreover, this is happening in an environment in which prices were already accelerating. Eurozone inflation in February rose to 5.8% y/y according to the flash reading, up from 5.1% in January and well above consensus expectation of 5.3%. The pick-up was broad-based across countries and product categories, with inflation accelerating in all the bloc’s biggest economies. And as household consumption was expected to be the main driver of growth this year, inflation remaining higher for longer and confidence likely to be hit, this assumption may no longer be valid.
Moreover, we are very likely to see some disruption in the industrial sector, which will continue to be under enormous pressure, particularly in energy-intensive sectors. And while the largest economies do not have a high proportion of production inputs in manufacturing sub-sectors that are coming from Russia, some industries such as German car makers are already reporting a hit to their supply chains. And with global supply already strained, it will be difficult to quickly replace Russian and Ukrainian products, resulting in a further negative effect in some sectors.
Unfortunately, this will represent a shift from the recent quite positive data that we have been seeing. The final composite and services PMIs for February saw downward revisions from their flash estimates but still signalled a strong pick-up in momentum after virus-related headwinds weighed on growth in January. However, this is now an out-of-date picture.
A slower than expected growth
Russia’s invasion of Ukraine also means that more negative scenarios, such as the one presented here, are now plausible. In this scenario, which sees the conflict lasting well into 2023 and a series of sanctions imposed by the west and retaliation from Russia via a cut in gas supplies, the impacts are much larger.
In this downside scenario, the impact on Russian GDP is very severe at 7% below our no-conflict baseline in 2023, and severe but lower on the eurozone at 3.2% down in 2023. Russian GDP is expected to contract by 3.1% in 2022, rebounding by only 1.4% in 2023. Eurozone GDP growth slows to around 2% this year and 1% in 2023 (Figure 1).