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Europe Macroeconomic Update: Conflict in Ukraine Worsens European Outlook

In this latest edition of the DBRS Morningstar Macroeconomic Update for Europe, we discuss how Russia’s invasion of Ukraine has worsened the economic outlook in Europe.

Key highlights:
EURO AREA
-- DBRS Morningstar expects slow growth in the EA in the near term, as economic activity is affected by Russia's invasion of Ukraine, especially through weaker confidence and higher inflation. Consumer confidence fell in March to its lowest level since May 2020, likely reflecting concerns over the impact of energy price increases on household finances. The conflict is also adding to existing supply shortages and disrupting trade further, through bans on exports and imports and financial sanctions.
-- Price pressures, to a large extent emanating from high energy prices and supply shortages, have intensified and are expected to last for longer than previously anticipated. This is especially the case as Europe tries to wean off Russian gas and the conflict in Ukraine continues.
-- Downside risks to the EA economic outlook could materialise from rising geopolitical risks, including disruptions in gas supplies from Russia, and renewed pandemic-related restrictions. In DBRS Morningstar's view, further deterioration in confidence and additional inflationary pressures, especially if combined with prolonged gas disruptions or an oil embargo, could lead to a downturn by weighing on consumption, which has supported the demand-driven recovery so far.

UNITED KINGDOM
-- After some rebound in economic activity at the beginning of this year, DBRS Morningstar expects UK growth to weaken in the near term, largely as a result of the cost of living pressures. In addition to the weakening in consumer spending, government spending is set to be a drag on growth, through significantly lower fiscal support to the economy and higher taxes.
-- Despite monetary tightening, inflation is yet to peak, as the increase in the energy price cap takes effect in April 2022, and another increase is expected later in the year. Household savings accumulated during the pandemic have now fallen back to previous levels, and thus are unlikely to provide a significant cushion against inflation in the coming months.
-- Downside risks to the UK economic outlook include higher inflation, worsening supply bottlenecks, and renewed pandemic-related restrictions. Although the UK's reliance on Russia's oil and gas is limited, disruptions in Russian oil and gas supplies are still likely to impact the UK economy, through higher energy prices.

“The conflict in Ukraine is affecting European economies by weakening sentiment, increasing inflation and worsening existing bottlenecks. An intensification of the conflict and higher inflation now pose the main downside risks to the economic outlook in Europe in the near term”, notes Adriana Alvarado, Senior Vice President in the Global Sovereign Ratings Group.