Surge in energy prices delays expected peak in inflation

Russia’s invasion of Ukraine has increased tensions in a commodity market that was already stretched and has led us to move from the core scenario formulated at the end of last year towards our upside scenario that factors in heightened geopolitical tensions.

We now believe the all-time high of USD145 for Brent oil recorded in July 2008 could be tested. Meanwhile, gas supply difficulties and higher gas prices would boost demand for oil to produce electricity. Conditional to the developments on the ground in Ukraine, so there is a strong possibility that oil prices will continue to flare in the short term. We think that Brent could test its all-time of USD145 per barrel in the short term.

Europe is particularly vulnerable to disruptions in energy supplies, having entered the winter with very low gas storage levels. What’s more, 40% of the region’s gas comes from Russia, and rapidly substituting this supply is unrealistic. Disruptions to gas and electricity supply cannot be ruled out.

In addition, Russia accounts for 14% of global wheat exports and Ukraine 10%. Weather-related issues affecting American, European or Australian crops could therefore cause further increases in food prices.

The impact of the surge in energy and food prices means higher global inflation in the short term. Hopes that inflation would peak over the summer are having to be revised. The latest sharp rise in energy prices will further dent households’ purchasing power and companies’ margins, potentially triggering precautionary saving behaviour. The authorities could react by introducing additional supportive fiscal policies. Europe is clearly much more exposed to stagflation than the US due to its vicinity to Ukraine and its energy dependence on Russia.