No Cause For Complacency As The Russia-Ukraine Conflict Modestly Dents Growth
The Russia-Ukraine conflict's global macroeconomic effects for now seem moderate after a healthy start to 2022, including strong household balance sheets in the advanced economies.
But risks are clearly on the downside: The conflict will influence direct trade effects, energy and commodity prices, confidence, and policy responses, particularly in China.
We have lowered our GDP growth forecast by 0.6 percentage point (ppt) to 3.6% globally, by 0.7 ppt to 3.2% in the U.S., and by 1.1 ppt to 3.3% in the eurozone. We think China's policy response will keep growth stable at around 5%.
Inflation has moved front and center as a policy challenge: Higher U.S. dollar rates will tighten financial conditions, moderate growth, and spill over to other economies, while the ECB tightening will be much more gradual.
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U.S. economic activity remained largely healthy through early March, based on our real-time indicators. Omicron infection rates subsided and restrictions were removed, allowing more people to get outside and spend. While COVID-19 appears to be in the rearview mirror (for now), the Russia-Ukraine conflict worsens already troubling pricing pressures tied to continued supply-chain disruptions. The impact on the U.S. economy is relatively moderate when compared to the pain felt in countries closer to the center of the storm, but ramifications are still noticeable.
We expect the economic damage to lower U.S. GDP growth to 3.2% this year, matching our preliminary forecast in early March but a full 70 bps lower than our November forecast of 3.9%. The main drivers for weaker than expected growth this year and the next are continued supply chain disruptions, exacerbated by the Russia-Ukraine conflict; higher prices, particularly for food and energy; and much more aggressive Fed policy to fight these higher prices. Direct linkages with Russia are small (even smaller for Ukraine) and U.S. trade with Russia is concentrated in a few areas. U.S. exports to Russia are concentrated in machinery, aircraft, and vehicles, for example, while imports from Russia are concentrated in energy, metals, and fertilizer (see charts 1 and 2).
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The U.K. economy has rebounded to pre-pandemic levels of activity but now faces a historical surge in inflation. Russia's invasion of Ukraine has added extra pressure to already high global energy prices. Tighter monetary policy will add to the headwinds this year and into next year but should be beneficial thereafter by preventing inflation from becoming entrenched. More generally, both domestic and global financing conditions have also tightened and will be felt.
We have revised down our GDP growth forecast for the U.K. and now expect 3.5% for this year, compared with 4.6% in December. We see inflation averaging 6.3% this year, peaking at 8% in the second quarter before it gradually declines, barring an escalation of the conflict.
If a fresh energy price shock had to happen, now is not the worst time. In fact, were the economy not still benefiting from some recovery momentum and a carry-over from 2021 worth 2.6% of annual growth this year, we might be expecting the U.K. to be on the brink of recession. But, as things stand, growth will continue. This makes all the difference for future growth dynamics because no actual destruction is taking place. This extends to the labor market, which we expect to remain strong, with unemployment to rise only minimally if at all.
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The risks are stacking up for Asia-Pacific's incipient recovery. The war in Ukraine, U.S. policy rate rises, spiking energy prices, and escalating COVID cases in China are complicating the outlook for what has been healthy expansion in regional economies. S&P Global Ratings believes these new risks will generally present as inflation, and that they will dent an otherwise strong rebound from the pandemic.
Most Asia-Pacific nations are moving to a stance of living with COVID, with robustly positive economic effects. Vaccination levels are typically high. Governments and businesses have become better at adapting to outbreaks. The mood in many nations is that the pandemic is manageable, and that people can resume normal activity.
China, of course, is the big outlier. The country has stuck with its low-tolerance COVID strategy. This involves strict social distancing restrictions and lockdowns. Spreading omicron infections are testing the sustainability of this policy. The possibility of rapid transmission of omicron in China is a key risk to its economy. Indicatively, mobility restrictions in Hong Kong amid an omicron surge have set back the territory's economic recovery.
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As most emerging market (EM) economies continue to recover from the COVID-19 pandemic, the Russia-Ukraine conflict and inflation risks now dominate the outlook. The circumstances surrounding geopolitical tensions continue to evolve quickly in unexpected ways, and the implications for global economies are highly uncertain. In the near term, the conflict is likely to weigh on economic activity for most parts of the emerging world and raise inflationary pressure broadly.
The Russia-Ukraine conflict escalated midway through first quarter--at a time when macro data since our last Credit Conditions Committee (in November) had come in stronger than expected globally, including in most EM economies. Combined with historical revisions, overall real GDP growth in 2021 now appears to have been 7.3% for our sample of 16 EM countries, which is 0.3 percentage points (ppts) higher than we expected in November. Excluding China and India, EMs likely grew 5.6% during the year, materially above our 5.0% forecast. In the fourth quarter of 2021, Mexico, Philippines, and Thailand were the only economies in our sample with real GDP still below fourth-quarter 2019 levels.
The omicron variant of COVID-19 spread quickly, but its economic impact was limited. S&P Global's (previously IHS-Markit) manufacturing purchasing managers' index (PMI) in the first two months of the year point to decent industrial output growth even as omicron spread during the months. Aside from Russia, only four EMs (out of 12 reported in our sample)--Brazil, Malaysia, Mexico, and Turkey--appear to have been struggling before the conflict began (see chart 1). However, PMI surveys also suggest that supply chains remain stretched. Supplier delivery times are still lengthening (albeit at a slower rate), and backlogs of work building (see chart 2).
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The Russia-Ukraine conflict is hitting economies worldwide just as activity is recovering from COVID-19. As close neighbors to Russia and Ukraine, European countries are among the most exposed to the latest shock. Yet, the eurozone economy is coming out of the pandemic in a position of strength, with large buffers to protect itself against a full-year recession, unless severe downside assumptions materialize.
Survey data, such as the Purchasing Managers' Index, confirms that the recent omicron wave has done little to derail growth, with the expansion in services picking up in February. More precisely, sectors most hit by the pandemic like hospitality, tourism, and retail have not yet recouped their end-2019 levels of activity (see chart 1). A full recovery of the two most affected sectors--arts and entertainment and wholesale and retail sales, transport, and accommodation--would add about 1 percentage point to eurozone GDP this year.
