Ukraine-Russia Conflict Poses Threat to Eurozone Economic Prospects


Eurozone economic growth is expected to pick up this year following a slowdown at the end of 2021, but any escalation in tensions over Ukraine could threaten the prospect of an upturn, economists say.

While the easing of supply-chain problems, slowing inflation and the expectation that consumers will spend some savings accumulated during coronavirus lockdowns all support a positive outlook, an intensification in the crisis over Ukraine could lift energy prices and in turn push up inflation, one of the main challenges for the eurozone economy.

The eurozone’s annual rate of inflation rose to a record high of 5.1% in January, more than double the European Central Bank’s target, driven mainly by higher energy prices.

“Such continued upward pressure on inflation could ultimately encourage the European Central Bank to begin policy rate increases earlier than some market participants currently expect,” Eiko Sievert, credit analyst at Scope Ratings, told The Wall Street Journal.

A serious escalation could push oil prices up by $25 a barrel and gas prices by 90 euros ($102.76), hitting the eurozone in a very vulnerable spot, economists at Bank of America said. According to the bank’s calculations, that would mean headline inflation at 4% in 2022, rather than the 3% currently expected.

“It would become increasingly tough to ignore the real income squeeze,” the economists said. They warned that 50 basis points of gross domestic product growth could be at risk.

According to Capital Economics’s estimates, European natural gas prices could plausibly return to their peak of EUR180 per MWh from the current price of EUR75, which would boost eurozone inflation by 1.5 percentage points. Taking into account higher oil and coal prices, the overall boost to inflation could be larger, although governments might take on fiscal costs to limit the pass-through to customers, Capital Economics said.

“Europe is really dependent on Russia for energy,” Philippe Waechter, chief economist at Ostrum Asset Management, told The Wall Street Journal. According to the latest Eurostat data, published in October, 24.7% of the EU’s petroleum oil imports and 46.8% of total gas imports came from Russia in the first half of 2021.

Mr. Waechter said he expects energy prices to remain high in 2022, although he highlighted their volatility. The situation also differs across countries. France and Spain are much less reliant on natural gas supplies from Russia than countries such as Germany, Hungary and Slovakia, which have a high proportion of natural gas in the mix of energy they consume, according to Scope Ratings.

“The planned inclusion of natural gas in the EU Taxonomy reflects its role as a crucial transition fuel in the EU’s shift to a low-carbon economy,” Scope Ratings said. The EU’s reliance on imported gas is therefore likely to further increase over the medium term, as the use of coal and nuclear energy in some countries is gradually phased out and domestic gas production continues to fall, the ratings agency said.

Higher energy prices would have a negative effect on household and corporate incomes, Capital Economics said. But, while this could slow the economic recovery, the economic research firm said it wouldn’t have as much impact on economic growth as other factors like the coronavirus pandemic, employment growth and households being cautious when spending their excess savings accumulated in lockdowns.

“Higher energy prices could also force governments to run bigger deficits in order to compensate households for high energy bills,” Capital Economics said.

While the EU’s imports from Russia are dominated by fuel and mining products, Russia remains an important destination for EU-made machinery and transport equipment, Eiko Sievert from Scope Ratings told The Wall Street Journal.

“Economic sanctions, including the possibility of expelling Russia from the SWIFT payment system, could significantly disrupt this trade,” he said.

Another way in which any Ukraine-Russia conflict could damage the eurozone economy is by hurting consumers and business sentiment. “Tensions in Ukraine also pose a further downside risk to the outlook, with any escalation of the situation likely to further dampen business confidence,” IHS Markit’s chief business economist Chris Williamson said in the press release of the eurozone purchasing managers indexes for January.

The Crimea crisis in 2014 led to a fairly swift deterioration in German manufacturing sentiment, but spillovers were otherwise more contained, economists at Bank of America said.

French President Emmanuel Macron’s visits to Moscow and Kyiv this week was a positive step toward reaching a diplomatic resolution in the standoff between Russia and the U.S. and NATO, Oxford Economics’s lead economist Tatiana Orlova said.

The next set of events to watch for will be German Chancellor Olaf Scholz’s visits to Ukraine on Monday and Russia on Tuesday. “Given that Russia needs to preserve economic ties with Germany, especially in light of [the] Nord Stream 2 [gas pipeline connecting Russia and Germany] awaiting local regulatory approval, we expect further positive signals to emerge from those meetings,” Ms. Orlova said.

The probability of the conflict being resolved diplomatically has increased following these diplomatic efforts, Ms. Orlova said.

Any economic fallout would probably be fairly small and short-lived, Capital Economics said. The economic fallout from a conflict would depend on the extent and duration of any action, it said.

Write to Maria Martinez at