Ukraine turmoil adds to cost-of-living crisis and fears of even higher inflation

The cost-of-living crisis in Britain and Europe deepened on Friday after Russia’s attack on Ukraine over fears inflation will surge even higher and the price of food, energy and fuel will rise sharply.

With western nations imposing tough sanctions to damage Russia’s economy and military assault, the conflict and the associated economic fallout will reverberate around the world.

In Britain, which was already grappling with a cost-of-living squeeze and inflation of 5.5 per cent in January, consumer confidence dropped in February by the most since coronavirus lockdown restrictions were announced in March 2020 as the decline in living standards gained traction.

GfK’s monthly consumer confidence index fell to minus 26 in February from minus 19, while its index-tracking sentiment towards personal finances for the coming year tumbled to its lowest ebb since April 2020.

“There’s clear anxiety in these findings as many consumers worry about balancing the household books at the end of the month without going further into debt,” said Joe Staton, client strategy director at GfK.

In the eurozone, a sentiment gauge by the European Commission rose to 114.0 in February from 112.7 the previous month, more than expected. However, the data was collected only until February 18 and does not reflect the latest attacks.

“The crisis in Ukraine is set to hit sentiment in the near-term, with rises in energy prices denting real incomes for consumers,” said Rory Fennessy, economist at Oxford Economics.

Britain’s households were already bracing in April, when energy bills are expected to rise by up to 54 per cent after the UK energy regulator Ofgem raised the price cap – the maximum suppliers are allowed to charge in a year – by £693.

Meanwhile, the government is pushing ahead with rises to National Insurance contributions from April – with workers set to pay an extra 1.25 per cent a year – and the cumulative effect is set to lead to households being £1,200 a year worse off from April.

The Ukraine crisis will exacerbate the situation with the potential of a third interest rate rise from the Bank of England in March meaning consumers face “a perfect storm of worries”, Mr Staton said.

Inflation could hit 8.2% within weeks

Britain’s inflation rate rose to an annual rate of 5.5 per cent in January, taking prices to a 30-year high, with the Bank of England expecting inflation to hit 7.25 per cent in April – more than triple its 2 per cent target – when the energy bill surge and higher taxes take effect.

However, the Ukraine crisis amplifies this outlook with some analysts expecting inflation to peak at 8.2 per cent driven by rising food, energy and fuel prices.

Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said that inflation figure could be hit within weeks if yesterday’s rises were sustained, before falling back to 6.5 per cent by the end of the year.

In the eurozone, consumer price inflation reached 5.1 per cent in January, with energy prices by far the largest contributor to this rise, increasing by almost 30 per cent compared with January 2021.

Economists at Oxford Economics said the obvious way the Russia-Ukraine conflict will affect economies would be through higher oil, gas and some non-energy commodities, with wheat and corn prices set to push up agricultural food prices, which are already about 30 per cent higher than a year ago.

Taking all these economic shocks into consideration, Oxford Economics expects average annual headline inflation in the eurozone to hit 4.6 per cent this year and 1.3 per cent in 2023.

Supermarket shopping will become even pricier

Consumers are already grappling with soaring food costs after drought and labour shortages slashed harvests around the world at a time of rising demand.

Now the prices of grain and cooking oil have taken another leap upwards after the invasion of Ukraine, a country which has been nicknamed "the breadbasket of Europe".

Ukraine and Russia together account for more than a quarter of the global trade in wheat, as well as a fifth of corn sales. Port and railway closures in Ukraine have already started to throw the nation’s commodity exports into chaos.

Tom Tugendhat, chairman of the UK Foreign Affairs Committee, said: "10 per cent of the world’s wheat is grown in Ukraine and the idea that this year’s is going to be a good crop, I’m afraid, is for the birds.

"This is absolutely one of those moments where we’re going to see the cost-of-living crisis driven by war."

It is not only the threats to grain shipments that could drive inflation. Russia is also a major low-cost exporter of nearly every kind of fertiliser vital to the food supply chain. If global trade gets disrupted, it will mean higher costs for farmers across the globe, and in turn, rising food inflation.

Prices are already surging for everything from wheat to corn to soybeans. A war that would stop Ukrainian grain exports would likely drive wheat prices up by another 30 per cent, and corn by 20 per cent, say analysts at Rabobank.

“Between them, Russia and Ukraine export a quarter of the world’s wheat, and Ukraine is a major corn exporter," said Thomas Pugh, an economist at RSM UK.

"This would put further upward pressure on food prices, which were already rising by four per cent year on year in December. All this will exacerbate the cost-of-living crisis and depress GDP growth.”

High energy bills will continue to rise

Britain’s energy bills are already eye-wateringly high after the fallout from the pandemic, but the conflict has driven the oil price to its highest level in more than seven years.

Russia supplies 10 per cent of the world's oil and a third of Europe's gas, with significant volumes heading to the continent through Ukraine, mainly to countries such as Austria, Italy and Slovakia, as well Germany and Poland.

While the UK sources only 6 per cent of its crude oil and 5 per cent of its gas from Russia, the EU is more exposed with almost half of its gas supply coming from Russia, and a 62 per cent jump in prices on Thursday testified to jitters around what the immediate future will bring.

Gas prices may have retreated on Friday and while analysts say Russia is unlikely to block supplies to Europe for a prolonged period, it is something that cannot be ruled out.

If Russian supplies to Europe were completely cut off, then prices could rise so high that it could trigger energy rationing.

As a result, annual household energy bills in the UK could rise to £3,000 by October, says Investec analyst Martin Young, pushing more families into fuel poverty and more businesses to breaking point.

This is £1,000 higher than the figure expected in April of slightly less than £2,000 when the price cap changes.

The increase could be “devastating” for British households, said Mr Young, some of which will face a “eat or heat dilemma”.

UK petrol prices set to surge past £1.70 a litre

Russia’s military escalation has sent oil prices above $100 a barrel for the first time since 2014, with Brent Crude, the international benchmark, hitting $106 on Friday.

The cost of fuel surged to record highs as consumers feel the heat from surging wholesale oil prices.

But analysts have given a warning of more price increases, with those on lower incomes "having to make difficult choices as a result of needing to put fuel in their cars", said Simon Williams at UK motoring organisation RAC.

Petrol hit £1.49 a litre on Thursday – inching ever closer to the £1.50 milestone – with expectation of £1.70 or higher to come very soon.

If the situation in Ukraine continued "you can forget about petrol at £1.70 a litre ... it will be significantly higher", he said.

The crisis could also affect the car market at a time when the industry is still reeling from a global chip shortage and pandemic-induced supply chain challenges.

Russia is one of the biggest suppliers of nickel, used in lithium-iron batteries, and palladium, which is used in catalytic converters.

If it decides to cut off the supply of these metals in retaliation to sanctions, car manufacturers’ supply woes would increase with companies seeking out alternative options and prices likely to rise in response.

Expect travel disruption and higher flight prices

With oil prices going up, airlines may decide to pass on the rise in the cost of aviation fuel to customers, causing flight prices to rise.

The travel industry is still recovering from the hit to revenue from the Covid-19 pandemic, which led to planes being grounded at the start of the crisis and passenger demand has dampened since.

The UK on Thursday said it was banning Russian planes from its airspace in retaliation for the unprovoked invasion, with Moscow responding on Friday by banning all UK-linked planes, including transiting flights, from its airspace.

IAG, owner of British Airways and Spanish airline Iberia, said on Friday it was rerouting aircraft to avoid flying over Russian airspace.

However, the group, which expects to turn a profit from the second quarter after posting a smaller-than-expected, adjusted operating loss for 2021 of €2.97 billion, said it did not expect a material impact from what it called "recent geopolitical developments", and is “monitoring” the situation.

Investors should brace for more turbulence

While global stocks plunged on Thursday as investors absorbed the news of the Russian invasion, the mood was slightly calmer on Friday.

European stocks rose as investors welcomed co-ordinated western sanctions against Russia that targeted its banks but left its energy sector largely untouched, while the FTSE100 rose 1.2 per cent after plunging 3.9 per cent on Thursday, its worst day since the summer of 2020.

The jump in stocks was modest, however, and markets remained down significantly from levels at the start of the week.

"Markets seem to be reducing tail risks. Additional sanctions announced against Russia matter to Russia, but the domestic Russian economy does not matter much to the global economy (and energy supplies are still flowing)," said Paul Donovan, chief economist at UBS Global Wealth Management.

Citigroup is telling investors to "buy the dip” as it does not see the war-fuelled market activity transforming into a sell-off.

Sterling on the other hand is headed for its biggest weekly drop in six months as investors turn to safe-have currencies such as the US dollar and yen.

The British pound stabilised on Friday, recovering from a two-month low hit in the previous session after investors rushed into safe-haven currencies such as the Japanese yen and the US dollar.

Against the dollar, the pound steadied at $1.3376 after falling to $1.3302 on Thursday, while against the euro, the pound edged 0.2 per cent higher to 83.52 pence.

Further interest rate rises may be delayed

The BoE has raised its benchmark rate twice since December and financial markets had been expecting it to increase the interest rate again to 0.75 per cent in March, despite the central bank forecasting a slowdown in the economy.

However, the Ukraine tension may change that picture because it will deepen the cost-of-living crisis around the world, stunting economic growth in the process – a problem which will be worsened by higher interest rates.

In the eurozone, European Central Bank policymakers might be more cautious at their next meeting on March 10, despite a consensus to normalise policy before the conflict broke out.

ECB officials have given a warning that the shock of war hanging over the continent has clouded the outlook, with chief economist Philip Lane saying the conflict could reduce the economic bloc’s output by 0.3 per cent to 0.4 per cent this year.