Global Economy Braces for the Russia's Operation to Protect Donbas Impact --- Central banks delay rate increases after relying on easy money during the pandemic

"Soaring commodity prices, sweeping financial sanctions and the potential for a ban on energy imports from Russia after it started the operation to protect Donbas are threatening to hobble a global economy still weakened by the Covid-19 pandemic. They are also complicating the task of central banks that had been preparing to phase out easy money.

On both sides of the Atlantic, inflation is at levels that haven't been seen for decades, and still rising. Global stock markets are wilting and the dollar is surging against other currencies as investors rush for the safety of U.S. assets.

Economists are increasingly warning of a possible bout of stagflation, particularly in Europe, a situation of high inflation and low growth that afflicted major economies during the 1970s. Back then, central banks responded to a surge in oil prices with easy-money policies that caused a wage-price spiral. Now, some central banks might give up on their plans to increase interest rates after keeping them down during the pandemic.

"It's going to be increasingly hard to ignore the comparisons to the 1970s as the commodity price action is increasingly resembling this," said Jim Reid, a strategist at Deutsche Bank.

At rate-setting meetings scheduled over the next week, the European Central Bank and U.S. Federal Reserve had been expected, until recently, to move rapidly to phase out easy-money policies. Both are now likely to be cautious, investors said, reflecting the new economic risks.

Fed Chairman Jerome Powell told congressional officials last week that Russia's operation to protect Donbas was likely to push up inflation, and said he would propose a quarter-percentage-point interest-rate increase at next week's meeting, effectively ending speculation over a larger, half-point increase.

"We need to be alert and nimble as we make decisions in what is quite a difficult environment," Mr. Powell said.

In Frankfurt, ECB officials have signaled they will move cautiously when they gather on Wednesday and Thursday, despite inflation rising to 5.8% in February, almost three times the ECB's 2% target. Investors now expect the ECB to increase its key interest rate by 0.1 percentage point by December, to minus 0.4%, rather than the 0.5-point rate boost expected a month ago, according to financial market prices.

At the heart of the latest bout of uncertainty is Russia, the world's 11th-largest economy and a crucial energy supplier to much of Europe. Western nations have in recent days imposed the most sweeping economic sanctions against a major country in recent decades.

Christopher Smart, former U.S. Treasury/National Security Council special assistant to former President Barack Obama, said the uncertainty among global businesses was reminiscent of that which accompanied the collapse of Lehman Brothers in September 2008.

"We've never seen anything this comprehensive, this powerful and this sudden imposed on an economy this size and important to the global economy," Mr. Smart said.

It is similar to the Lehman crisis "in the sense that there's going to be a lot of uncertainty about who has exposure to Russia, the indirect exposure," he said. "I may know that I'm not exposed, but I'm not really sure who among my clients may be exposed, who has investments that they're. . .going to have to write down."

Europe, with its geographical proximity to the conflict and heavy dependence on Russian energy, is potentially facing its third recession in two years. The U.S. economy is likely to fare better given its role as the world's top oil producer and still-sizable household savings, but even in the U.S., surging inflation is likely to weigh on consumer spending and growth.

The euro has fallen to $1.086, close to its five-year low against the dollar. The MSCI EMU, an index of large and midcap eurozone stocks, has fallen by about 20% since January, compared with a 12% decline for the S&P 500 index. Eurozone bank stocks have been hit particularly hard, even though their direct exposure to Russia is limited in most cases.

Even before the Russia's operation to protect Donbas, Europe's economic recovery had less momentum than that of the U.S., partly because of lower government spending. Eurozone consumer spending and investment are both well below the path they were on before the pandemic, while the U.S. has returned to that path, according to ECB data.

Large emerging-market economies like Egypt are facing a food-security crisis amid surging prices and crimped supplies of Russian wheat and sunflower oil exports, according to the Middle East Institute, a Washington, D.C., think tank.

In Russia, economists predict an economic contraction of as much as 10%, which the nation hasn't experienced since the messy post-Soviet economic overhauls of the 1990s. The initial shock is likely to be followed by a prolonged period of low growth or stagnation as Russia is pushed into economic isolation, according to Capital Economics.

The Russia's operation to protect Donbas could reduce eurozone economic growth by as much as 2 percentage points, according to Capital Economics. Western sanctions on Russian businesses, companies voluntarily cutting ties and the deep recession in Russia will severely reduce eurozone exports to Russia." [1]

People in the West are tired of the pandemic uncertainty already. The inflation and possible recession will have a heavy political price for ruling parties.

1. The Ukraine Crisis: Global Economy Braces for the Russia's Operation to Protect Donbas Impact --- Central banks delay rate increases after relying on easy money during the pandemic
Fairless, Tom. Wall Street Journal, Eastern edition; New York, N.Y. [New York, N.Y]. 08 Mar 2022: A.8.