The Russian attack on Ukraine and the swift and determined sanctions imposed on Russia as a response by the West has triggered the biggest geopolitical crisis in Europe since the Second World War with soaring commodity prices reawakening fears of stagflation (rising prices and stagnant growth) or even a global recession similar to the oil price shocks in the 1970s.

But even in Europe where the economic consequences of both war and sanctions are much more direct than in the US and China, an EU-wide recession is not a foregone conclusions, writes Danske Bank’s team of macroeconomists in a new publication Big Picture: Headwinds to the global economy from Ukraine war and Fed tightening.

Erosion of disposable incomes
With rising prices already a concern before the war, higher commodity prices could see headline inflation in the euro area hitting eight or nine percent in coming months, spelling the biggest erosion of disposable income in decades for European consumers while uncertainty, supply chain bottlenecks and tighter financial conditions will also weigh on business sentiment.

But the European and the global economies were in a relatively good state when war and uncertainty hit, says chief analyst at Danske Bank, Jakob Ekholdt Christensen.

"First of all, the global economy was seeing a relatively strong momentum ahead of the Ukraine war. And given its relatively small size in the global economy, exports to Russia are limited except for some Nordic and Eastern European countries. The biggest impact on global growth will come through the impact of higher commodity prices on inflation and real incomes but real incomes should recover as inflation declines and wage growth accelerates," says Jakob Ekholdt Christensen.

"Furthermore, helped by the stimulus in China, strengthening economic activity will also spill over to higher export growth in the US and euro area. In Europe, we expect public and private investments to pick up speed, to boost the green transition and energy efficiency to reduce dependency on fossil fuels," he adds.

Between a rock and a hard place
After more than a decade of accommodating and expansionary monetary policies, the world’s central banks were already under pressure before the war to tighten monetary conditions in the face of elevated levels of inflation. With commodity prices now soaring even higher, this pressure increases, limiting their abilities to provide the support that investors and financial markets had almost come to expect in the face of economic setbacks over the past decade or more.

"Already high inflation and further price pressures from higher commodity prices pose a dilemma for Western central banks about how to mitigate the weakening growth outlook. We have raised the inflation trajectory for both US, euro area and China. We expect both the Fed and ECB to continue their normalisation of monetary policy, perhaps at a slightly slower pace than prior to the start of the war. This adds to the current tightening of financial conditions weighing on economic growth. The exception is China, where much more muted inflation pressures provide room to stimulate growth through modestly expansionary monetary and fiscal policies," says Jakob Ekholdt Christensen.