ALEX BRUMMER: Uncertainty around Ukraine, interest rates and overheated pandemic valuations are casting a pall over equity markets
- In the US, the Nasdaq has fallen 10 per cent since the start of the year
- There were big pre-weekend falls on Europe’s exchanges
- The FTSE 100 is less vulnerable than others due to its strong energy component
No one quite knows how the stand-off over Russia’s military build-up in the Ukraine will resolve itself.
There has been a thundering verbal response from Nato boss Jens Stoltenberg and a muddled, less convincing intervention from Joe Biden. Diplomatic doors are being kept open.
Britain has upped the ante by dispatching anti-tank weaponry to Kiev. Conflict is invariably beneficial for BAE and the rest of the UK’s leading edge defence and aerospace sector. For a global economy struggling with supply chain problems, the strategic stand-off could hardly be in a worse place or at a worse time.
Uncertainty: There were big pre-weekend falls on Europe’s exchanges with the FTSE 100 less vulnerable than others as a result of its strong energy component
Way back after the Yom Kippur war in 1973, and later after the first Iraq war in 1990, the main worry for advanced nations was blockages in the Gulf of Hormuz or a Gulf states oil embargo. As Europe has become less dependent on the Middle East for its energy needs, the flashpoint for security of supply has moved across the Urals to Russia and its control of pipelines.
Under Angela Merkel’s leadership, Germany allowed itself to become far too dependent on Moscow. When Japan’s Fukushima nuclear plant erupted in 2011, Merkel suspended nuclear output and investment making the country more dependent on imported gas.
A more recent decision to burn less coal in order to meet carbon emissions objectives, increased that Russian dependency.
The new Nord Stream pipeline, designed to ease capacity constraints on existing connectors, is in danger of becoming caught up in the Ukraine crisis with swingeing Western sanctions on President Putin’s Russia looming.
All of this is casting huge uncertainty over the future of energy prices and rapidly changing the inflation outlook.
As recently as October 2021, the Office for Budget Responsibility forecast that consumer price inflation would be 2.3 per cent in 2021 and 4 per cent this year. The latest data shows annual consumer price inflation hit 5.4 per cent in December and could hit 7 per cent in the spring.
Forecasting wholesale oil and gas prices can be very tricky. Irrespective of what happens in the Ukraine, the prospects are not encouraging. Brent crude futures rose 50 per cent in 2021 and have already climbed a further 14 per cent since the start of 2022, hitting a seven year high of $89-a-barrel.
At a moment when inventories are low and geopolitics is affecting production in several parts of the world, investment bankers Goldman Sachs, among others, are projecting an oil price of $100-a-barrel by midyear. Natural gas prices track oil in what is likely to be a profound inflation shock.
There are some signs that the supply bottlenecks which have been a big part of the inflation surge are easing.
The RSM UK supply chain index showed some improvement in December, but there is no confidence that the adjustment to the post-pandemic era is over.
The emergence of the Omicron variant in China, where coronavirus started two years ago, is leading to new factory and port closures. This, in turn, could put upward pressure on prices. Finally, central banks are waking up to the idea that the current bout of inflation is anything but temporary.
The Bank of England led the way among advanced central banks when it raised bank rate from 0.1 per cent to 0.25 per cent in December.
With inflation now forecast by market analysts to peak at 7 per cent in the spring, the expectation is of a further 0.25 percentage point rise in February and predictions of rates climbing to 1.5 per cent by year end.
No longer is the Old Lady out on her own. Norway has already raised rates and the Federal Reserve this week hinted at a policy hardening. The European Central Bank finally appears to be listening to its German council member Isabel Schnabel who has been warning for some weeks that swelling energy costs could be persistent and a response may be necessary.
Uncertainty around Ukraine, interest rates and overheated pandemic valuations are casting a pall over equity markets.
In the US, the Nasdaq has fallen 10 per cent since the start of the year and former New York stars Netflix, and more severely Peloton, are being punished. There were big pre-weekend falls on Europe’s exchanges with the FTSE 100 less vulnerable than others as a result of its strong energy component. It has less distance to fall because of its chronic under-performance since Brexit.
We live in turbulent times, but no need to buckle in just yet.