The economic impact of the crisis in Ukraine

The shockwaves from the tragic events in Ukraine continue to reverberate around the global economy. Several weeks on from the invasion, markets have retreated from their recent highs, but uncertainty remains elevated. What is clear is that rising costs for energy and other commodities will add to inflationary pressure in the UK and elsewhere in the months ahead, squeezing household incomes. Disruption to trade in key raw materials has the potential to exacerbate existing bottlenecks in global supply chains.

The conflict has also triggered a profound shift in geo-political priorities which will have significant economic implications for the medium term:

• Moves by the US, UK, EU and other countries have been made to scale back imports of energy from Russia, placing energy security at the top of political agendas and accelerating commitments to energy diversification
• Military spending across Europe is set to rise
• European countries are likely to have to absorb millions of refugees in the coming months.

Read this analysis for a short-term view of the immediate impact on the UK economy. It focusses on four main transmission channels:

1. Higher global commodity prices
2. Trade disruption
3. Financial market volatility
4. Increased uncertainty.

Initial reflections from CBI members appear to confirm that the first two of these are the most important. But though the transmission mechanisms are clear, the scale of the impact remains much less certain.

Summary of the findings:

• At a macro level, higher energy prices are the greatest concern for the UK economy, resulting in further upward pressure on inflation and a moderate hit to GDP growth over the next two years
• Russia’s share of UK energy imports is low. However, Europe’s high dependency on Russia for its energy supplies represents a significant downside risk to economic activity, with even small disruptions to supply sufficient to curb European production and send global energy prices higher
• The UK’s direct trade with Russia and Ukraine is limited, but their role as exporters of key raw materials means disruption to global supply chains is likely. Global prices for non-energy commodities—eg, industrial metals and foodstuffs—have also surged
• Although individual banks and companies with operations in Russia and Ukraine are having to adapt to sanctions and voluntary curbs on business with Russian entities, Russia is a relatively small economy, which should help contain the risk of “contagion” through the global financial system
• The prospect of further increases in energy prices sharpens the dilemma facing the Bank of England’s Monetary Policy Committee. The MPC must weigh up the near-term impact of higher commodity prices on domestic inflation against corresponding hits to demand (via the impact on real household incomes and firms’ earnings)
• While heightened uncertainty might normally encourage the Bank to adopt a “wait-and-see” approach, given existing concerns around near-term inflation expectations and wage-price dynamics, higher energy and commodity prices are likely to persuade the MPC to raise interest rates further in the coming months, though more gradually than previously expected.