Weekly review 14 March 2022: What kind of impacts can the crisis in Ukraine have in the short and long terms?

Last week, against expectations, the ECB announced that it would tighten its monetary policy. Was the central bank’s strict policy such a big surprise after all?

Earlier this year, the ECB was expected to tighten its monetary policy due to accelerating inflation. The war in Ukraine changed the situation, however, and the central bank was expected to stay cautious, with the war weakening the economic outlook.

Nevertheless, the ECB surprised the markets after its last week’s meeting by communicating that it would tighten its monetary policy despite the economic growth uncertainty created by the war. The ECB announced that it would reduce its bond purchases during the second quarter and possibly stop buying bonds altogether by the end of the year.

Although the central bank’s announcement caught the markets by surprise, the ECB is only staying true to its mandate, i.e. securing price stability in Europe by keeping inflation in check. Had the ECB not addressed the ever-increasing inflation rate, its credibility would have taken a blow.

What other information did we obtain from the ECB’s meeting?

The only mention of an interest rate hike at the meeting was that it would take place after the purchase programmes have ended. Previously, the bank had signalled that the interest rate hike would take place ”shortly after” the purchase progamme has ended, but it changed the wording to ”some time after” the end of the programme. On the Friday after the meeting, the markets priced in one interest rate hike of 20 basis points for this year.

Furthermore, the ECB no longer suggested in its communications that interest rates could be lowered. So in practice, the next move in the interest rates will be upwards, which, of course, is to be expected.

The ECB’s message made it clearer that inflation is the central bank’s number one enemy and that it is less keen to come to the rescue of the markets than it used to be. After the meeting, interest rates rose and stock prices fell.

Is there any relief in sight for the USA’s high inflation figures?

The USA published new inflation data last week. At 7.9%, February’s inflation rate was still high compared to a year earlier, which was in line with market expectations.

Rising energy and commodity prices keep inflation pressures high, while the base effect will reduce the upward pressure in the upcoming months. So there is no relief in sight in the foreseeable future.

What kind of impacts has the Ukraine crisis had on the markets?

Stock valuation levels have come down as a result of the Ukraine crisis. Finnish and European stocks have suffered the most. On the other hand, Finnish and European stocks also showed the biggest reaction to last week’s positive news. The USA, Japan and the emerging markets have reacted more moderately to the crisis.

The rise in interest rates and widening of spreads after the outbreak of the crisis have depressed returns on fixed income investments. Credit risk premiums have been on their way up. Energy prices have surged as a result of supply squeezes. Long-term inflation expectations have continued to rise along with the crisis. Government bonds and the dollar, in contrast, have provided safe havens for investors.

What kind of impacts can the crisis have in the short and long terms?

 

Short term: Dramatic increases in energy and commodity prices Western sanctions and Russia’s possible countersanctions will send the global markets into a tailspin. Market restructuring cannot be achieved overnight. Possible changes in monetary policy The markets’ earlier expectations of rapid tightening of monetary policy have dissipated, especially in Europe. The central banks now have to weigh between rising inflation and possibly slowing growth. Slower economic growth Energy and commodity prices affect investments, raise companies’ costs and channel consumer spending toward household staples. Growth will slow, but how much?

Long term: Reconstruction of the European energy infrastructure The efforts to exit from Russian energy will disrupt Europe’s energy production. Investments in green energy will likely gain momentum; on the other hand, decommissioned fossil or nuclear energy will be re-commissioned. Slower globalisation  Dependency on global supply chains has taken blows in recent years, and the crisis in Ukraine is likely to further boost the transformation. The reconstruction of production chains requires investments and may cause structural pressure on inflation.

 

China’s Covid situation has worsened. What kind of impacts can this have in the big picture?

In Western countries, Covid news has been overshadowed by the war; yet, the pandemic is not over. China’s zero-Covid-policy is failing. In certain Chinese cities and in Hong Kong, Covid infections and deaths have hit their highest levels during the pandemic. The markets are now monitoring how China will tackle the situation.

In the big picture, the escalation of the Covid situation in China can have two types of impacts. Chinese stocks have been under pressure over the past few weeks anyway, and the escalation of the Covid situation is not going to help. Additionally, the escalation of the Covid situation would put even more pressure on global production and supply chains that are already struggling.

What should we keep an eye on this week?

In addition to the war, US retail figures are worth keeping an eye on. The figures will show how inflation and rising prices are affecting consumer behaviour. The USA is a very domestic-driven country, so US consumers are important for its economy.

Final inflation data for Europe will also be available this week. The highlight of the week, however, will be the Wednesday meeting of the Fed, which is expected to make its first interest rate hike. Markets are also on the lookout for the Fed’s other comments.

 

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