Jim Power: Conflict in Europe will only prolong inflation and heighten cost of living pressures
Russia's invasion of Ukraine will have huge economic consequences globally, with one being inflation likely staying higher for longer.
Just as the world was starting to emerge from the pandemic and there was a semblance of normality returning, everything has once again been thrown into turmoil by the Russian invasion of Ukraine.
Although things had been building up for some months, there was still an air of uncertainty about Vladimir Putin’s real motives, but, when news broke on Thursday morning that the Russian offensive had started, it felt a lot like 9/11.
While this is not the first war in Europe since the Second World War — the aftermath of the break-up of the former Yugoslavia has that distinction — it is a horrendous escalation and one which could have very severe political and military consequences for years to come.
In the midst of a deep humanitarian and military crisis in Ukraine it seems inappropriate to discuss the economic implications, however, life has to go on and it is important to consider the possible economic ramifications of what is happening.
All economic analysis, obviously, has to be caveated heavily, given that we have no real idea about how this situation is going to develop. The sanctions announced to date are modest and will likely have no impact on Mr Putin’s dangerous activities.
Notwithstanding that caveat, it is clear that the immediate economic consequences are significant.
From a global perspective, a war such as this and the sanctions that follow, create enormous economic uncertainty; distort trade flows; damage supply chains, and create volatility in financial markets.
Energy is the most obvious implication; the EU imports 41% of its natural gas from Russia and 26.9% of its crude oil.
The impact to those supplies will be serious and will further pressurise prices in an environment where energy prices have been at very elevated levels, largely as a result of Covid-19.
The evolving situation in Ukraine will damage global economic activity and will make the task of central bankers incredibly difficult.
For the past number of months economic activity everywhere has been bouncing back from Covid-related repressed demand; supply chains have broken down, and inflation has taken off.
The Bank of England has already tightened interest rates twice; the US Federal Reserve is/was expected to start increasing in March; and fears have been growing that the European Central Bank (ECB) could move later this year.
Developments in Ukraine are highly likely to change all of this. Although the latest escalation in energy prices is likely to ensure that inflation stays higher for longer, the negative economic impact could be greater than the inflationary impact.
Consequently, central bankers are likely to be more reticent about tightening policy, but particularly the ECB.
Ireland's direct trade links with Russia are small. Our merchandise exports directly to Russia totalled €627m last year, 0.4% of total merchandise exports. It is estimated that service exports totalled €3.2bn.
Ireland’s imports from Russia totalled €598m in 2021, with mineral, fuels and oils, and fertilisers the main components.
The imposition of sanctions would obviously do serious damage to this trade, but it is important to note that the sanctions announced at this point will have little impact on Irish trade.
The real impact is likely to be felt on the inflation front.
Irish inflation in recent months reached the highest level since 2001, but the hope was that as Covid-related supply chains and rebounding demand normalised, headline inflation would moderate. However, this prognosis has now been torn up.
Although Ireland does not import natural gas from Russia, the impact on global natural gas and oil prices has been significant, coming as it does on top of already elevated price levels.
In addition, elevated energy prices are and will continue to feed into other prices, particularly in areas like food production. Any threat to Russian wheat exports would also impact food price inflation.
The reality is that Ireland was already facing serious cost of living pressures, and these will now be compounded by the situation in the Ukraine.
We will have to live with significant rates of price increase for some time to come, and this will just exacerbate already very high costs of living in this country.
It is not clear what the Government can do about it, because populist measures such as the recent €505m cost of living package cannot be repeated every few weeks.
Perhaps consideration should be given to VAT and excise duty reductions, and an abandonment of the carbon tax increase in May.
All of the foregoing analysis should be treated with particular caution, as intense uncertainty now abounds and we can have no real certainty about how the situation will unfold.
However, we can be certain that current developments are extremely sinister and dangerous, and we can lament the damage that Boris and Trump have done to the unity of the US and EU over the past few years.
