The global consequences of the Russia-Ukraine war will grow as the conflict drags on, boosting inflation in the short term and weakening economic growth.

Sanctions applied to Russian banks in response to the invasion of Ukraine have cut off large parts of the country's economy, crushed the Russian ruble and slashed the share prices of Russia's energy giants like PJSC Rosneft Oil Co. and Public Joint Stock Co. Gazprom. Russia's economy is just 1.75% of global GDP, yet its outsized importance in the global supply of energy, agricultural products and metals mean that disruption to trade will have a significant impact on global growth.

The U.S. announced it would ban all imports of Russian oil, gas and energy on March 8. If the EU takes similar measures it would be hugely consequential as the economic bloc accounts for 48% of Russian exports of crude oil and condensate, according to S&P Global Commodity Insights.

"Sanctions restrict trade and economic and financial activity — therefore they hurt both the side that is sanctioned and the side that is sanctioning," Dhaval Joshi, chief strategist at BCA Research, said in an email. "Absent an unlikely back down from Russia, the sanctions noose will tighten, choking growth everywhere."

A prolonged crisis will slice 1 percentage point off of global growth in 2022, according to the Royal Bank of Canada. Oxford Economics forecasts a hit of 0.6 percentage point in 2022 followed by a further 1.1 percentage points in 2023 if fighting continues into next year. Wells Fargo is more optimistic predicting a decline of just 0.25 percentage point, cutting its forecast to 3.75% from 4%.

The European Union will take a bigger hit than the U.S. and Asia, owing to its dependence on Russia for oil and for 40% of its total gas consumption. European Central Bank Chief Economist Philip Lane believes the Ukraine conflict could shave up to 0.4 percentage point off of European GDP this year, according to Reuters. Others are more pessimistic.

"In the wake of the significant step-up in sanctions that have been announced since, we think that will likely be an underestimate of the actual impact," Peter Schaffrik, global macro strategist at RBC Capital Markets, said in an email.

RBC estimates the figure could be closer to 2 percentage points if energy prices remain elevated, while Swiss bank Union Bancaire Privée, or UBP, forecasts a hit to European growth of 1.7 percentage points.

Commodity supply crunch

The immediate global impact of the conflict has been an explosion in commodity prices as multiple markets face shortages.

Russia is the world's third-largest oil producer behind the United States and Saudi Arabia, accounting for 10% of global supply. Together with Ukraine, Russia also supplies 30% of the global wheat trade. Russia is also a major supplier of ammonium nitrate, used in fertilizer, and metals like palladium — used in automotive production and mobile phones — and nickel — used to make steel and electric car batteries.

Commodity markets have been convulsed by the war. The closely watched S&P GSCI index, which tracks 24 physical commodities including the benchmark West Texas Intermediate crude oil contract, has jumped to its highest levels since 2008 before a commodity crash. Prices were already elevated as supply chains struggle to recover from the impact of COVID-19.

UBP forecasts increased energy, grain and metal prices could add between 0.3 and 1.5 percentage points to eurozone inflation, keeping the rate above 5% over the next few quarters and the effects lasting until 2023.

For U.S. inflation to return to pre-pandemic levels — 2.5% in January 2020 — UBP calculates crude oil prices would need to be below $85 per barrel for the rest of 2022 and agricultural prices to fall by 20%, an increasingly unlikely scenario.

"Should the Ukrainian situation last, or unfortunately worsen — the most probable scenario in our view — then the rally we have seen might be just a small teaser of the massive spike higher which would be ahead of us," Kambiz Kazemi, chief investment officer at Validus Risk Management, said in an email.

The U.S. decision to ban imports of Russian oil and gas was announced on the same day that U.K.-based Shell PLC became the latest privately owned energy company to announce it would no longer buy Russian oil and gas, putting further pressure on alternative sources of supply.

Central banks face tough choices

In the long run, high energy prices are deflationary as rising bills reduce consumer purchasing power and raise costs for companies, reducing investment and economic growth. In the short run, however, rising energy and food prices will put further upward pressure on inflation numbers that are already at a 40-year high in the U.S.

All of this is making decisions harder for central banks keen to curtail inflation without choking off the economic recovery. The Federal Reserve was seemingly poised to raise rates by 50 basis points later this month but is now expected to be more cautious in its policy tightening. The CME Fedwatch Tool, a measure of investors' expectations for rate hikes, now puts no chance of a 50 bps rate hike at the next Federal Open Market Committee meeting on March 15-16.

"Russia's invasion of Ukraine, its impact on global energy prices, potential to fuel inflation and possible hit to economic growth as economic sanctions take effect is clearly prompting a shift in investors' expectations," Russ Mould, investment director at financial services group AJ Bell, said in an email.

S&P Global Commodity Insights and S&P Global Market Intelligence are owned by S&P Global Inc.