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Surging Price of Everything Spells Stagflation, Recession Risk

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What You Need to Know

  • Fuel, food and metal prices are rising after Russia’s invasion of Ukraine.
  • Economists at Barclays and JPMorgan Chase are among those lowering forecasts for global growth and raising them for consumer prices.
  • Europe is at particular risk, but the U.S. and Asia aren’t immune.

The global economy is at mounting risk of stagflation and potentially more recessions as fuel, food and metal prices surge after Russia’s invasion of Ukraine.

Fresh speculation that governments may slap sanctions on Moscow’s energy supplies catapulted oil above $130 a barrel at one point on Monday. European gas prices continued to fly higher after doubling last week, and wheat is near a record following Ukraine’s exit as one of the top global crop suppliers. Copper, palladium and other metals also keep rising.

With the world still to fully escape the coronavirus and supply chains fraying anew, the climbing cost of raw materials increasingly threatens a 1970s-style twin blow on companies and consumers via even faster inflation and weaker demand.

In question is whether economies will suffer stagflation or another recession just two years since the pandemic forced the deepest slump in decades. Europe, which uses Russia for about 40% of its gas needs, is at particular risk, although the U.S. and Asia aren’t immune either.

Economists at Barclays Plc and JPMorgan Chase & Co are among those lowering forecasts for global growth and raising them for consumer prices. Both expect expansion about a percentage point weaker and inflation a percentage point stronger than previously.

“Soaring commodity prices and increased risk aversion caused by the Russia-Ukraine war imply a stagflationary shock,” the Barclays economists led by Christian Keller wrote in a report. “While Europe looks more vulnerable than the U.S., and the U.K. is somewhere in between, China seems least exposed.”

Stagflation would sharpen trade-offs between expansion and inflation. Governments are under pressure to offset pain via greater spending, for example with subsidies to protect the poor from high energy costs. Meanwhile central banks will have to tread carefully even as the U.S. Federal Reserve still seems set to raise interest rates.

“The Fed has no choice but to hike in March, and we believe they will keep hiking beyond that despite the geopolitical risks,” Jefferies economists Aneta Markowska and Thomas Simons said in a report. “A 7- hike scenario still seems like a reasonable base case.”

The International Monetary Fund is warning of “very serious” economic consequences from the war. Goldman Sachs Group Inc. analysts estimate a sustained $20 shock in the oil price will lower gross domestic product by 0.6% in the euro area and 0.3% in both the U.S. and China.

Cutting off gas shipments through Ukraine could knock 1% off euro area GDP, while an entire loss of Russian gas would mean a 2.2% hit, the economists added. They reckon a complete shutting down of Russia’s 4.3 million barrels-a-day of oil exports to the U.S. and Europe would reduce global GDP by 3 percentage points.

Other than Russia, Ukraine and neighboring economies in Europe’s east, euro-area nations appear most at risk. Based on assumptions of energy prices at their new highs reached on Monday, Bloomberg Economics’s SHOK in-house model of the euro-area economy showed a contraction in the third quarter and 6% inflation this year.

Energy Prices Could Push European Inflation Above 6%

While inflation there is already at almost 6%, triple the European Central Bank’s official target, officials may choose to focus on supporting growth for now. Paolo Gentiloni, the European Union commissioner for the economy, warned last week that high energy prices “will likely weigh significantly” on growth.

“Exactly how badly the European economy will be hit is anyone’s guess at this stage, but the post-Covid recovery will surely be significantly delayed,” Erik Nielsen, chief economic adviser to UniCredit Group, said in a report. He sees a risk “of stagflation — if not even a recession with inflation.”

Even more pessimistic was Gilles Moec, chief economist at AXA Investment Managers, who said losing a percentage point off GDP growth this year “now looks optimistic.”

While Asia has broadly swerved the inflation seen elsewhere, the sudden surge in energy prices will flow through to consumers in a region that’s a net importer of oil, potentially hitting manufacturers and exporters.

Consumer prices and production costs in Asia had been accelerating before the Russian invasion, and the region is vulnerable to higher food costs.

“For much of last year, price pressures had stayed relatively muted,” said Frederic Neumann, co-head of Asian economic research at HSBC Holdings Plc. “The cyclical outlook for 2022, with growth expected to remain soft, also didn’t point to any hurry to raise rates. Well, that’s starting to change.”

There are shock-absorbers. The omicron variant is in retreat, households and businesses built up savings during the pandemic and most labor markets have tightened. China is also now targeting growth of about 5.5% in 2022, the higher end of many economists’ estimates.

Still, it wouldn’t be the first time that rocketing oil prices have hurt global growth. A doubling of the crude price in 1973-74, 1978 and 2007-2008 all presaged recessions. But adjusting for inflation, it would need to exceed $170 to surpass its 2008 record, according to National Bank of Canada.

Paul Donovan, global chief economist at UBS Wealth Management, said the overall result may only partially resemble 1970s stagflation.

While oil exporters will benefit, they spend much more nowadays than in the 1970s, which will support global demand, he said. Meanwhile households may also respond by turning down heating and air conditioning, and by eating in rather than dining out. Lower consumer demand could bear down on prices, Donovan said.

Businesses can also find efficiencies: U.K. factories are already temporarily halting production during peak daily energy demand, and restarting when electricity prices drop. The world is also less reliant on crude than it once was.

With global goods trade at record levels, the hit to consumer demand will potentially lead to a production overhang which will also bear down on prices, Donovan said.

“We are not going to see anything as severe as the 1970s,” he added.

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