“There are stagflation scenarios in front of us” according to one member of the ECB’s governing council, Mario Centeno. The term which describes rising inflation in a stagnant or contracting economy is a nightmare scenario for central bankers, as putting up interest rates to curb inflation only serves to slow growth, whilst cutting rates to boost growth fuels inflation – the proverbial rock and a hard place. The big variable is the duration of the war, but all previous forecasts for how high inflation was going to go have been torn up and we’re likely to see price rises above already high expectations as the year progresses, though over the longer term these price rises will weigh on growth and therefore inflation which might serve to bring things back into line – we just have to get through the short to medium term pinch.
The Bank of England’s deputy governor has said that the large adjustments underway in financial markets, as investors and companies are all racing to get out of Russian assets, aren’t a risk to financial stability. He said that the long-term financial impact of the invasion is not clear, but the severe damage to Russia’s economy isn’t systemic and though we’ll be suffering with higher inflation we shouldn’t worry about a return to 1970’s situation. The Bank isn’t yet clear on what the war will mean for its rate tightening cycle, but markets are already forecasting a slower roll out of rate rises in the UK, with a 25-bps hike still on the table for March, but no chance of a 50-bps hike and a much higher likelihood that we stay around 1.5% by the end of the year.
The sanctions have led Fitch and Moody’s to downgrade Russia’s sovereign credit rating to junk status. Both ratings agencies went for a six-notch downgrade, which hasn’t happened to a country since South Korea in 1997 at the start of the Asian financial crisis. The ratings agencies cited the sanctions on the Russian Central Bank as Russia’s largest problem, as they make Russia’s foreign exchange reserves largely useless and they also said that the ratings downgrades may create a negative feedback loop, where investors are forced to sell a sub investment grade asset at any price, which in turn results in more downgrades, which in turn results in more selling.
So far, the US has avoided sanctioning Russian gas and oil, which is a small mercy to the Kremlin. Last year Russia received about $120bn in tax revenues from oil and gas exports, which was only increasing as energy prices continued to rise – in October they were receiving about $500m per day and for every $10 increase in a barrel of oil the treasury receives an extra $60m a day. However, even without sanctions in place on the product, they are struggling to find buyers that are willing to risk sanctions, or even if they are, the banks that they would use to make payment aren’t willing to make the payments for fear of falling foul of sanctions. This means that this tax revenue could very quickly dry up even if the US don’t sanction the product.
Global commodity prices are also at 14-year highs as the prospect of hindered supplies and further sanctions on Russia hit investor sentiment. For example, the S&P GSCI index which tracks a broad range of commodity prices around the globe has risen 37% in 2022 alone – with around a 4% increase early this morning. Central to this is of course the increase is the rise price of oil, gas and agricultural produce. Regarding agriculture, Russia and Ukraine account for ¼ of the world’s wheat supply. Hence, wheat prices in on the CME have increased close to 40% since the start of the year while soyabeans have seen a 28% rise. Analysts are considering how the increase in these wholesale prices will disproportionately affect the cost of food in the developing world where recent inflation is already causing significant pressures on households.
UN on Russia
Yesterday, the United Nations voted to condemn Russia’s invasion of Ukraine, calling for an immediate withdrawal of Russian forces there. The resolution reaffirmed the sovereignty territorial integrity and independence of Ukraine and involved 141 members adopting the resolution while 35 abstained. The five members who voted against it was Belarus, North Korea, Eritrea, Syria and…Russia. The United Nations estimates that the number of refugees that have left Ukraine has hit one million with half of these people going to Poland. Moreover, with the fighting intensifying the humanitarian crisis is likely to get worse moving forward and hence the UN estimates that some 12m Ukrainians will require relief and protection and are seeking $1.7bn.
Have a great day.