Executive summary
This week marks two years since the Russian invasion of Ukraine, which sent energy prices and inflation surging, intensifying monetary tightening around the world. In this edition, we take stock of the economic consequences, for the Russian economy, energy markets, Europe and capital markets:
- Russia: strong growth reflects war economy rather than resilience. Stronger-than-expected real GDP growth in 2023 (+3.6%) reflects the redeployment of resources towards war industries and construction, disguising the underperformance of most other sectors. We forecast growth of +2.5% in 2024. Withdrawals from the National Wealth Fund will ensure that Russia’s fiscal deficit will remain manageable this year but financing may become challenging thereafter. The current account surplus narrowed markedly in 2023 as exports plunged while imports rebounded, helped by sanctioned EU exports still making their way into Russia through third countries. However, foreign investment has dried up as investors shy away from Russia.
- Energy markets: unplugging from Russia comes at a great cost. Europe is managing successfully through a second winter without Russian gas, thanks to energy savings and increased LNG flows. But energy prices are still +35% higher, and Europe has also doubled subsidies to fossil fuels to shield households and firms. The only silver lining comes from the rising weight of renewables in the energy mix – but that effort needs to be sustained over the longer run.
- Europe: double the inflation, double the interest rates. We calculate that the war pushed Europe’s already-high inflation up by an additional +5pps, prompting the ECB to hike rates by +200bps more than it would have in the absence of the war in Ukraine. European corporates have benefited from pricing power, keeping profitability resilient. But households’ purchasing power has dropped, with energy and food bills jumping by EUR673 and EUR1,316, respectively, despite substantial government support (4% of GDP on average) that has stretched European public finances even further.
- Capital markets: higher bond rates, higher volatility. Although capital markets seem to be regaining some bullish traction and corporates’ growth engines seem more resilient than previously anticipated, the additional ECB rate hikes have led to an extra 50-70bps being added to the long-end of European sovereign curves, an extra 5 to 10% decline in equity market performance and an around 40-50bps extra widening of corporate spreads, which has led to substantial additional losses in EUR exposed portfolios.