The conflict in Europe will only prolong inflation and increase pressures on the cost of living
As the world began to emerge from the pandemic and a semblance of normality returned, everything was turned upside down again by the Russian invasion of Ukraine.
Although things had been piling up for a few months, there was still an air of uncertainty as to Vladimir Putin’s true motives, but, when news broke on Thursday morning that the Russian offensive had begun, it looked very much like the 11 September.
Although this is not the first war in Europe since the Second World War – the consequences of the break-up of the former Yugoslavia have this distinction – it is an appalling escalation and one that could have very serious political and military consequences for the years to come.
In the midst of a deep humanitarian and military crisis in Ukraine, it seems inappropriate to discuss the economic implications, however, life must go on and it is important to consider the possible economic ramifications of what is happening.
Any economic analysis, of course, must be strongly cautioned, given that we have no real idea of how this situation will evolve. The sanctions announced so far are modest and are unlikely to have any impact on Mr. Putin’s dangerous activities.
Despite this caveat, it is clear that the immediate economic consequences are significant.
From a global perspective, a war like this and the ensuing sanctions create enormous economic uncertainty; distort trade flows; damage supply chains and create volatility in financial markets.
Energy is the most obvious implication; the EU imports 41% of its natural gas from Russia and 26.9% of its crude oil.
The impact on these supplies will be severe and will put further pressure on prices in an environment where energy prices have been at very high levels, largely due to Covid-19.
Developments in Ukraine will hurt global economic activity and make the job of central bankers incredibly difficult.
Over the past few months, economic activity around the world has rebounded on the back of suppressed Covid-related demand; supply chains collapsed and inflation took off.
The Bank of England has already tightened interest rates twice; the US Federal Reserve is expected to start rising in March; and fears are growing that the European Central Bank (ECB) could move later this year.
Developments in Ukraine are very likely to change all that. Although the latest escalation in energy prices is likely to ensure that inflation stays higher for longer, the negative economic impact could be greater than the inflationary impact.
Therefore, central bankers are likely to be more reluctant to tighten policy, but especially the ECB.
Ireland’s direct trade links with Russia are weak. Our direct merchandise exports to Russia totaled €627 million last year, or 0.4% of total merchandise exports. Services exports are estimated to have totaled €3.2 billion.
Irish imports from Russia totaled €598 million in 2021, the main components being minerals, fuels and oils and fertilisers.
The imposition of sanctions would obviously seriously harm this trade, but it is important to note that the sanctions announced at this stage will have little impact on Irish trade.
The real impact should be felt on the inflation front.
Irish inflation in recent months has hit its highest level since 2001, but the hope was that as Covid-related supply chains and the rebound in demand normalized headline inflation would ease. would moderate. However, that prognosis is now torn.
Although Ireland does not import natural gas from Russia, the impact on world natural gas and oil prices has been significant, adding to already high price levels.
In addition, high energy prices are and will continue to fuel other prices, especially in areas like food production. Any threat to Russian wheat exports would also have an impact on food price inflation.
The reality is that Ireland was already facing severe cost of living pressures, and these will now be compounded by the situation in Ukraine.
We will have to live with significant price increase rates for some time to come, and this will only exacerbate the already very high cost of living in this country.
It’s unclear what the government can do about it, as populist measures such as the recent €505m cost-of-living package cannot be repeated every few weeks.
Perhaps cuts in VAT and excise duties should be considered, and a drop in the carbon tax increase in May.
All of the foregoing analyzes should be treated with particular caution, as intense uncertainty now reigns and we cannot have any real certainty about how the situation will develop.
However, we can be certain that the current developments are extremely grim and dangerous, and we can bemoan the damage that Boris and Trump have done to US and EU unity over the past few years.