Sunday, February 27, 2022
War will slow our recovery but shouldn’t finish it off
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

How many shocks can we take? After the two “once in a lifetime” shocks, the financial crisis and pandemic, Russia’s invasion of Ukraine has led to many warnings of the biggest war in Europe since `1945. You will have seen and read many accounts of this, including in this newspaper. My task today is to try and assess where it leaves the economy, and it is far from straightforward.

When, last month, forecasters published their predictions for the global economy in 2022, their expectation was for relatively strong growth, though weaker than last year, alongside higher inflation. The International Monetary Fund (IMF) predicted 4.4 per cent global growth alongside inflation averaging almost 4 per cent in advanced economies (and nearly 6 per cent in America).

The effect of Russia-Ukraine will be somewhat slower growth, though not a world recession, and somewhat longer-lasting inflation. That inflation effect will come through higher and more prolonged increases in oil and other energy prices, including crucially, gas, and higher process for food commodities, notably what. The oil price, which has already moved back above $100 a barrel, is unlikely to reach the all-time high of almost $150 it reached in 2008 but could easily hit the $120s.

For the UK economy, this means that two essential questions will again be asked. The first is whether consumers will continue to spend when faced with an even more intense cost-of-living squeeze.

Even before news of the invasion, consumers were getting gloomier. The latest GfK consumer confidence index, for this month, published on Friday, showed a seven-point fall to -26, its lowest since January 2021, when the country was in lockdown and the vaccination programme was in its infancy.

Disturbingly, the biggest fall in confidence, of 12 points, was in people’s expectations for their personal financial situation over the next 12 months. This, rather than more general fears over the economy, is what drives people’s spending decisions. There was also a drop in the major purchase index.

With inflation set to peak this spring rather higher than the Bank of England’s 7.25 per cent forecast, and even higher on the retail prices index (where inflation is already well above 7 per cent), this drop in confidence is not surprising. Letters and emails are arriving informing people how much their gas and electricity direct debits are going to eb rising and they are pretty eyewatering. Petrol is the most visible price in the economy and we will soon get used to well over £1.50 a litre.

What all this means for consumer spending is that the heavy lifting will be done by two things: the strength of the labour market and the large stock of savings, almost £200 billion, that households built up during the pandemic. Before the latest developments, economic forecasters surveyed by the Treasury thought that these factors would be enough to lift consumer spending by between 5.5 and 6 per cent this year.

Some of that reflects what economist would call base effects, and the comparison with a weak first quarter of last year, when spending fell. Most of it reflects the view that many people will save less, borrow more and spend some of their accumulated savings, thus looking through the cost-of-living squeeze. It would be a huge shift to go from that kind of prediction to a fall in consumer spending, so we should still be looking for a rise, but a smaller one than was expected. Retailers and other consumer-facing businesses will find it tougher.

Part of the calculation about consumer spending will be that it depends on what businesses do. We have entered this crisis with the labour market tight, vacancies high and employers competing, in some sectors, for scarce labour. As long as firms want to recruit, and the evidence is that they do, any fallout for the job market should be limited.

The other question, and it is my second one about the outlook, is whether the uncertainty will deter businesses from investing. Business investment is more than 10 per cent below pre-pandemic levels and, though investment intentions are strong in business surveys, those surveys tend to be dominated by rising cost and price pressures. There should eb a rise in investment this year, but the jury is still out on how strong it will be.

If all this sounds a bit gloomy – a recovery but not as good as hoped – is there a light at the end of the tunnel? If we look at the oil price, most comparisons show that is at its highest since 2014, which was when Russia annexed Crimea. The history of the oil price is that it spikes and then falls, though some of those spikes can last for a time.

After the 2024 highs, oil prices then recorded one of their biggest falls in history, falling by 70 per cent in 2015-16 and delivering the UK its lowest inflation rate – zero in 2015 – its lowest since the early 1960s. High prices had the effect of bringing forward more supply and prices fell in consequence.

Will history repeat itself? A fall after a spike is likely but not guaranteed. One of the countries which responded to higher prices by increasing supply in 2015-16 was Russia, and it may have its own reason for not doing so this time. Members of the Organisation of Petroleum Exporting Countries (Opec) are currently increasing output to pre-pandemic levels and debating whether to go further in response to high prices.

The other complication is gas, which normally gets a lot less attention than oil, but not now. It had some down from last autumn’s highs but has increased. Whether it will also follow the spike pattern and move lower, to the considerable relief of households and businesses, remains to be seen. The only honest answer is that the outlook for gas prices is highly uncertain. Futures prices suggest a fall but they may not be a reliable guide.

Adding all this up, even with potential lights at the end of the tunnel, the outlook has plainly darkened. Russia is a rogue state, and its actions should not drive us into recession, and indeed are unlikely to do so. But they will damage growth prospects, at a time when we need all the growth we can get.