Rising stagflationary headwinds from Ukraine conflict

• The Ukraine conflict is not only creating upward pressure on euro area energy prices, but also food and core inflation items. We see upside risks to our base line HICP inflation forecast of 4.7% of ca. 0.5pp in 2022 in light of the latest developments. However, should oil and gas prices stay at elevated levels throughout the rest of the year, inflation rates well in excess of 6% could be on the cards for H2 22.
• We see downside risks to our 2022 euro area GDP forecast of 4.0% of 0.4-0.5pp, mainly through the adverse hit to consumers from continued high inflation.
• We think the hit to European exports will be manageable, as trade links to Russia are of small importance for most euro area countries. However, an exclusion of Russia from the SWIFT system could create some wider adverse repercussions to global trade flows, especially for commodities. Sanctions could especially hurt Germany's car sector.
• Heightened uncertainty could weigh on business sentiment in the short term, but an accelerated implementation of renewable energy and energy efficiency projects as well as defence spending could end up boosting investments.
• Germany has performed a significant policy U-turn and stepped up defence and energy spending, which may open up for a larger political discussion on how these areas should be treated under the upcoming Stability and Growth Pact rules review.
• Many unknowns remain, especially what role China will play to limit the economic fallout for Russia and the scale of disruptions to gas supply. Europe would most likely survive a large-scale disruption to Russian gas imports in the short-term, but running the economy for several years without Russian gas would likely entail measures to curb demand, with clear disruptions to economic activity.

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