Oliver Mangan: Ukraine conflict set to keep markets volatile
Damaged radar arrays and other equipment is seen at Ukrainian military facility outside Mariupol, Ukraine. Picture:AP Photo/Sergei Grits
The initial reaction in financial markets to Russia’s full-scale invasion of Ukraine was along expected lines, with rising risk aversion and a flight to safety.
This saw stock markets fall back, credit spreads widen, bonds rally and safe-haven currencies like the dollar, yen and Swiss franc make ground.
However, the first batch of sanctions announced by Western governments were not as severe as anticipated in terms of their economic and financial impacts, which are likely to be more evident over the medium term. This saw the initial moves in financial markets reverse somewhat, though, stock markets have come under fresh pressure with the announcement of further sanctions.
Meanwhile, many commodity prices have risen sharply on concerns about disruptions to supplies, with Russia a major player in some of these markets. Most notably, oil has risen above $100 per barrel, with wholesale gas prices spiking even higher.
Heightened uncertainty in regard to Ukraine is a factor that markets will have to contend within the coming weeks, so we can expect to see a continuation of the increased volatility that has been evident in recent days. It is difficult to know how the situation in Ukraine will unfold.
The economic implications, though, are fairly clear, with even higher inflation on the cards in 2022.
The eurozone is more exposed than other larger economies, given its reliance on gas imports from Russia, though its exports to the region are relatively small.
Central banks now have to weigh a new element in their monetary policy deliberations as they try and balance higher inflation as a result of the crisis with its negative impact on activity. They are unlikely to change their minds about the need for higher rates, but will probably adopt a more cautious approach to policy changes.
It is hard to see either the US Federal Reserve or Bank of England hiking rates by more than 25 basis points at their March meetings.
The ECB may not announce much of a change to the tapering or planned scaling back of its bond purchase programme at its policy meeting next week. It is also likely to want to retain flexibility around monetary policy so long-term guidance may be limited. There has been a tightening in financial conditions recently, in any event, which gives central banks a bit more leeway. Markets still expect that rates will get to around 2% in the UK and US by next year and climb towards 0.75% in the eurozone.
This probably reflects a view that the global economic recovery will remain intact and elevated inflationary pressures will still require a significant degree of rate tightening. Furthermore, this crisis is only starting to unfold.
We expect markets to remain very volatile, with risk aversion the dominant theme.
- Oliver Mangan is chief economist at AIB
