Economic Fallout From Russia’s Invasion Will Be ‘Modest’—But Inflation Will Surge Higher, This Expert Predicts

Topline

While Russia’s invasion of Ukraine is taking a “massive” human toll, the global economic fallout is likely to remain “modest,” according to a recent note from Moody’s Analytics chief economist Mark Zandi, though he predicts the U.S. economy will still feel the effects of higher inflation due to surging energy prices, and said the stock market remains at risk of a further sell-off.

Russia’s invasion of Ukraine has caused a surge in energy prices that could lead to higher … [+] inflation, experts warn.

Anatolii Stepanov/AFP via Getty Images

Key Facts

Russia’s invasion of Ukraine—and the subsequent surge in oil prices—is “especially bad timing” for the U.S. economy as it deals with “already painfully high” inflation, Zandi said in a new note on Monday.

Stock prices are down around 10% from all-time highs at the start of the year (a loss of approximately $5 trillion in market capitalization) as investors prepare for higher interest rates, but the Russia-Ukraine conflict could heighten the risk of a sell-off, numerous experts have recently warned.

If inflation expectations start to rise as a result of higher oil and gas prices, the Federal Reserve “will have little choice” but to raise interest rates more aggressively than previously forecast (with investors already anticipating as many as seven 0.25% rate hikes in 2022), Zandi argues.

The prospect of more aggressive interest rate hikes also “increase[s] the odds that the economy will stumble,” he says, predicting that if oil prices stay at around $100 per barrel for a “sustained” period of time, that would add as much as 0.5% to year-over-year inflation, which is already at a 40-year high of 7.5%.

That would still only have a “modest impact” on the U.S. economy, according to Zandi, who argues that the most likely scenario is that Russia’s military goes no further than Ukraine and the disruptions to energy markets will be “limited and temporary.”

“The impact on the U.S. economy isn’t likely to be significant,” though higher oil prices will certainly put a dent in consumer confidence, agrees Lindsey Bell, Ally’s chief markets & money strategist, in a recent note.

Contra:

The fallout from Russia’s invasion “means the Fed is going to have to be even more careful and it’s going to have to tolerate higher inflation,” Allianz chief economic advisor Mohamed El-Erian told CNBC last week. “Historically, when inflation gets this high and the Federal Reserve has lost its inflation credibility and has lost the policy narrative, they are forced to slam on the brakes,” he said.

Tangent:

While the global economic fallout from the invasion will likely remain “modest,” according to Zandi, “it will be a different story for the Russian economy, which is set to take a massive hit” as Western governments unveil harsh sanctions. Although Europe’s economy is more likely to take a hit (as it relies heavily on Russia for natural gas), “its economic recovery will continue,” Zandi predicts, though he adds Russia’s economy will “suffer a debilitating recession” from sanctions. Russia has some $650 billion in reserves, he points out, but the sanctions will cut them by “significantly more than half.” That prospect makes it more difficult for the Russian central bank, which recently more than doubled interest rates to 20%, as it scrambles to support the ruble, which fell up to 30% against the U.S. dollar on Monday. “The totality of the sanctions imposed will be a big hit to the Russian economy, and we expect Russia to suffer a serious recession this year, even more severe than that experienced during the pandemic,” Zandi says.

Big Number: $80 Billion

If oil prices stay at $100 per barrel for a while that will end up costing U.S. consumers approximately $80 billion more at the gas pump, Zandi estimates. Numerous experts have recently predicted that oil can surge even higher, up to $130 per barrel if the conflict jeopardizes global supply. Analysts at JPMorgan, meanwhile, predict that oil will fall back to $90 per barrel by later this year because even if Russian energy exports decline, a potential nuclear deal between the United States and Iran could help offset lost supply in an already tight market.

What To Watch For:

Other scenarios for how Russia’s invasion of Ukraine might play out. If Russia halts its exports of oil and natural gas altogether, “it is plausible under this scenario that oil prices will spike closer to $150 per barrel,” Zandi predicts. The “darker” scenario is that Putin extends his invasion beyond Ukraine, which would cause “severe” damage to the global economy and make a global recession “unavoidable,” he adds, though it would also “push the reeling Russian economy even deeper into the abyss.”