UBS: How the war in Ukraine affects GDP and energy prices – Why eurozone stocks remain an attractive story

Her Eleftherias Kourtali

The war in Ukraine has raised investor concerns about the economic outlook, with the eurozone’s dependence on Russia for oil and gas being the focus, UBS said in a report today. In its baseline scenario, it does not expect energy supplies to fall, but prices are likely to remain high until tensions ease. Higher prices are likely to weigh on consumption, but inflation targets above high as a result of high oil and gas prices are unlikely to force the European Central Bank to tighten its policy sooner than expected. In this context, UBS estimates that Eurozone shares will perform better, given the underlying strength of the economy, the ECB’s exit from negative interest rates and attractive valuations.

The financial impact

The human tragedy that will come from the Russian invasion of Ukraine is huge, as the Swiss bank points out. The geopolitical landscape of Europe has changed forever. Financially, there will also be significant consequences both in the short and long term.

In the short term, the economic impact will be felt through higher energy prices, sanctions and confidence. In terms of energy prices and, above all, supply, UBS continues to estimate that energy supplies will continue to flow from Russia to Europe, as in previous periods of geopolitical tensions. The sanctions regime and the Russian countermeasures that will become clearer over time will help reduce uncertainty. Short-term price volatility is inevitable, but UBS maintains its estimate that oil prices will trade in the $ 90-100 a barrel range this year. Upward “explosions” above this level are possible, but from an economic point of view, what matters most is the duration of higher prices. Clearly, if oil prices remain above US $ 100 a barrel for a period of six months, this is of greater concern than if they lasted six weeks.

According to the Swiss bank, If energy prices are about 10% higher than expected for about six months, the impact could lead to eurozone GDP as a whole in 2022 by about 0.1-0.2 percentage points lower. At the moment, it is not lowering its GDP forecasts, but is aware of the risks. However, even if energy prices were rising sharply, for example above $ 125 a barrel, the impact would not be enough to reverse the recent recovery momentum. Thus, the Eurozone economy will continue to grow this year.

Sanctions against Russia, which will primarily affect trade, could increase pressure on GDP, but again the impact will be marginal. Eurozone exports to Russia are small, accounting for about 0.5% of GDP. Of course, energy imports make sense, but, as mentioned above, we will see minimal disruptions, although this is an area to be monitored.

In terms of the impact on trust, this is always the most difficult area to judge, as noted by UBS. However, experience from previous financial crises suggests that most of the impact is felt relatively quickly, tends to be greater for investment projects than for consumer spending, and trade remains relatively unaffected.

Therefore, as he emphasizes, it is possible that growth in the Eurozone will be below expectations as a result of the war in Ukraine, but this will not be enough to reverse economic growth. ΤThe next key question is how policymakers will react to the ECB.

In any case, higher energy prices will mean higher inflation for a longer period of time. According to UBS, it is very likely that when the ECB publishes its next financial forecast on March 10, the conditions for raising interest rates will be met. However, higher inflation due to higher energy prices does not automatically mean that policymakers will “tighten” policy. Higher inflation, in the absence of wage growth, will act as a deflationary shock, as households and businesses have to reallocate their spending to take into account higher fuel and energy costs. If employees manage to negotiate higher wages, this can be a concern for policymakers. For now, however, the risks are moving towards a slower pace of normalization of the ECB monetary policy in the coming months.

Eurozone stocks are still the preferred market

While the Eurozone’s geographical close proximity to Ukraine and its dependence on Russia for natural gas pose a risk to growth, the market has depreciated by 13% in two months with the P / E index moving at 13.5x. This valuation is in line with the long-term average, which UBS considers relatively attractive as bond yields remain low in absolute terms.

So, at least some of the risks have been assessed and a combination of strong global growth and falling inflation could quickly make the picture more favorable.. The Eurozone is in a particularly good position to take advantage of strong global growth and rising returns thanks to the fact that it is a “value” trade and also a cyclical trade. This is reflected in the recent results of the fourth quarter, which once again significantly exceeded expectations and are expected to lead to further short-term upgrades in profit forecasts, despite the risks that the Russia-Ukraine conflict will lead to sharply higher commodity prices.

Within the Eurozone, UBS prefers shares of attractive value that can benefit from reopening the economy, stockpiling and government spending. Industry-level preferences are Energy and Healthcare, which are expected to prove resilient during the escalation of the Russia-Ukraine conflict, thanks to rising oil prices and its defense / quality profile. UBS is also positive about the commodities sector, stocks and “value” sectors, and those who will benefit from the opening up of the economy as well as government spending plans such as digital technology and the transition to alternative energy sources. .