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Moody’s Analytics: The Two Scenarios and the Impact of War on Economy, Energy, Fiscal and Monetary Policy

Her Eleftherias Kourtali

Moody’s Analytics is considering two scenarios for the possible effects of the war in Ukraine on the world economy. In the rapid resolution scenario, war quickly gives way to a ceasefire. In the scenario of the long conflict, a long confrontation between the Russian troops and the Ukrainian army results in high humanitarian and economic costs. In both scenarios, the economic consequences of the invasion, international sanctions, and pressures on oil and gas supplies are examined. The chances for a Quick Resolution and a Long-Term Conflict are 55% and 30%, respectively. This reflects the high uncertainty we face but also the strong impact even if the war ends soon, as Moody’s Analytics points out, with a positive scenario (with very little impact on the economy) having only a 15% chance of not is being examined.

Scenario 1: Quick solution (Chance: 55%)

The first scenario envisages a rapid resolution of the invasion of Ukraine with a ceasefire that will be implemented in a short time. The US, EU and other countries have announced sanctions against Russians, individuals, companies and financial institutions, which limits their ability to engage in the international economy. Sanctions are also imposed in some sectors, in particular on the extraction, production and transport of fossil fuels and defense-related trade. In this scenario, given its energy security, the EU is carefully weighing its options, but is delaying indefinitely the adoption of Nord Stream 2. Russia is responding by continuing its current strategy for reduced gas supplies to Europe and keeping up the pressure. in global gas markets. Short-term cuts in Russian oil and gas supplies follow. Europe seeks to offset this by replacing lost Russian gas with LNG from other parts of the world, and financial markets, worried about the possibility of further conflict, maintain high risk premiums for oil and gas.

In the short term, Europe is meeting its energy needs through a combination of measures including increased LNG supplies, a shift away from coal to gas and reserves. In the medium term, the increase in Russian supply and the larger LNG capacity in Europe are restoring gas prices to lower levels.

Oil prices are rising slightly as Brent reaches $ 110 a barrel, while European gas prices are most affected, reaching $ 35 per million BTU. As a result, global inflationary pressures are rising, with Europe bearing the brunt of the impact. Concerned about the negative effects of inflation, the Fed continues to tighten its policy and even the European Central Bank is convinced of the need to tighten and raise interest rates by the end of 2022. Inflation is squeezing disposable income and the consumer climate weakening, leading to a slowdown in global growth.

Scenario 2: Long-term conflict (Chance: 30%)

The second scenario is a much darker one, with the invasion of Ukraine turning into a protracted conflict. This results in a humanitarian catastrophe in Ukraine and provokes a united and strong response to US and EU sanctions. This is followed by retaliation from Russia through the reduction of oil and gas supplies to Europe. In this scenario, Russian troops occupy the capital, Kyiv, and establish a new government. A fierce clash ensues as the Ukrainian army fiercely resists parts of the country. The human and economic costs are high, as fighting leads to civilian casualties, damage to economic infrastructure and shortages of basic goods, although the country’s economic institutions continue to function. There is a strong sense of unity among the NATO alliance, which is leading to a rapid accumulation of NATO troops in the region in an effort to prevent Russia from invading surrounding nations.

Russian oil and gas companies are having difficulty paying as a result of the SWIFT blockade, which of course reduces the volume of oil and gas Russia wants to supply. In addition, Russia is acting to further reduce supply to Europe in order to put pressure on the EU.

As a result, the price of Brent crude jumps to $ 150 a barrel, while European gas prices reach $ 50 per million BTU. There is no quick solution to this controversy and the EU is forced to build a medium-term energy security strategy that seeks to weaken its traditional dependence on Russia.

In terms of markets, investors are fleeing massive risk and quality in global asset markets as risk assets correct sharply and the US dollar benefits from flows.

The EU bears the brunt of the shock in commodity prices, given the greater impact of gas shortages on energy price inflation. European governments are trying to support households through subsidies and tax cuts, but their actions do not prevent the region from experiencing significant inflation shock. The squeeze on disposable income is leading to a global recession, with the eurozone being more affected.

At the same time, monetary policy is diverging between large economies. In the US, the Fed remains focused on tackling inflation and launching a more aggressive cycle of interest rate hikes, while the European Central Bank, recognizing the special nature of the crisis in Europe, is on hold. The ECB is also stepping up its asset purchase program to assist governments as they provide budget support. The state of energy supply will take several quarters to resolve in this scenario and oil and gas prices are finally reaching a new equilibrium at very high levels, while Russia, one of the largest producers of oil and gas in the isolated even more politically and economically.

Source: Capital

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