Ukraine war to cut growth, up inflation

Key points

Macro impact
We see the Ukraine war reducing global growth, increasing inflation and putting central banks in a bind. We prefer developed stocks in the inflationary backdrop.
Market backdrop
Stocks led by European equities bounced from 2022 lows last week, as oil prices came off highs. The European Central Bank accelerated policy normalization.
Week ahead
The Fed is set to raise its policy rate by 0.25% this week – the first hike since the pandemic started. We still see a historically muted response to inflation.

We see an era of structurally higher commodities prices ahead. Why? First, look back. Prices ran up because the economic restart drove demand amid abnormally low supply. The West has tried to wean itself off Russian energy after years of declining investment. Now, look forward. We see structurally higher prices amid tight supply for energy and rising demand for metals that will be critical to power the path to reach net-zero carbon emissions by 2050.

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Energy shock

U.S. and European energy prices, 2021-2022

This chart shows that the portfolio diversification role of bonds when equities declined has become increasingly challenged, especially on days when stocks fell more than 1.5%.

Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, March 2022. The lines show the changes in price of different commodities since July 1, 2021. European natural gas price based on European Energy Derivatives Exchange futures, U.S. based on MYM-Henry Hub Gas futures price. Oil price based on ICE-Brent crude futures.

The Ukraine war has caused a spike in energy prices, putting a damper on growth and exacerbating supply-driven inflation. Europe is most exposed. Natural gas prices have surged beyond 2021 peaks, as the red line in the chart shows, before reversing a bit last week. The big difference with 2021: High energy prices are now the cause of a downdraft in growth, whereas they were the outcome of strong growth then. The culprit is Europe’s reliance on Russian gas in an already tight market. The powerful economic restart from the Covid-19 shock in 2021 had already exposed mismatches in the region’s energy supply and demand. This was aggravated by a mix of geopolitical factors and weather-related supply disruptions just as European inventories were low. The recent surge in European energy prices has pushed the region’s energy burden as a percentage of GDP to above levels reached in the early 1970s, we calculate, whereas the U.S. is still well below it. This is why we think the impact of the current energy shock for Europe could be on par with previous severe episodes such as the 1973 oil embargo.

Higher energy prices are a material, global shock. Europe is facing a large, stagflationary shock, in our view.  Analysts are ratcheting down their growth forecasts and upping their inflation projections. This is not over, and we believe the European Central Bank (ECB) growth forecasts understate the shock’s impact on growth. The U.S. is in a better spot, in our view. The shock is less than previous energy crises. The U.S. also has a larger growth cushion thanks to the strong restart’s momentum – even if some of European weakness is bound to spill over.

How will policymakers respond to the poisonous combination of slowing growth and rising inflation? Central banks have to normalize policy as the economy no longer needs stimulus, we believe, so policy rates are headed higher. The ECB last week said it would phase out asset purchases and left the door open for a rate increase this year – the first in more than a decade. The U.S. Federal Reserve this week is expected to announce its first rate hike since the Covid shock, while the Bank of England and a slew of emerging market central banks are set to hold rates or raise them. We still see a historically muted cumulative response to inflation; more aggressive tightening would come at too high a cost to growth and employment. Central banks will be forced to live with inflation. But it’s tough to see central banks coming to the rescue to halt a growth slowdown in this inflationary environment. Our conclusion: central banks are less likely to shape macro outcomes going forward. That leaves fiscal support. The war has raised the prospect of fiscal stimulus to achieve energy security and up defense outlays, but we see this taking time. 

The imminent hit to growth has reduced the risk that central banks slam the brakes and aggressively raise rates to contain inflation. So what are the risks? In the short run, escalation of the war and more energy supply shocks are key catalysts for more risk-off market moves. We see a risk of inflation expectations becoming unanchored in the medium term, causing central banks to raise rates sharply. Energy prices are now driving growth, rather than being the result of it. This raises the specter of stagflation–something that was not in play before due to the economy’s strong growth momentum.

What does this mean for investments? We prefer to take risk in DM equities against the inflationary backdrop of negative real bond yields. We expect the global energy shock to hurt corporate earnings, especially in Europe. Recent market declines reflected this, we believe, and the region’s stocks are highly geared toward global growth. We stay underweight government bonds. They are losing their diversification benefits, and we see investors demanding greater compensation for holding them amid higher inflation and larger debt loads. Within the asset class, we prefer short-dated and inflation-linked bonds.

Spending shift drives inflation

Inflation is at historical highs because of a supply shock triggered by the Covid-19 pandemic. We think this will change once economies fully reopen. Read our macro insights.
BlackRock Investment Institute Macro insights

Assets in review

Selected asset performance, 2022 year-to-date return and range

The chart shows that Brent crude oil is the best performing asset this year to date among a selected group of assets, while European equities is the worst.

Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream as of March 10, 2022. Notes: The two ends of the bars show the lowest and highest returns at any point this year to date, and the dots represent current year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE U.S. Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, Refinitiv Datastream 10-year benchmark government bond index (U.S., Germany and Italy), Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global Broad Corporate Index and MSCI USA Index.

Market backdrop

Crude oil prices shot up to 14-year highs on supply concerns but then suffered their biggest one-day decline in almost two years. Equities followed suit, rebounding from plumbing new 2022 lows earlier in the week. The ECB said it would phase out asset purchases in the third quarter and left the door open for a rate increase this year. Peripheral bond spreads widened.

Week ahead

March 15China industrial output and retail sales; UK unemployment data
March 16 Fed monetary policy meeting; Brazil rate decision
March 17 UK, Indonesia and Turkey rate decisions
March 18 Russia rate decision

The U.S. Federal Reserve is expected to raise its policy rate for the first time since the Covid shock. The Bank of England (BoE) is set to announce its third hike, and a slew of emerging market central banks are set to hold rates or raise them.  Both the Fed and BoE are keen to normalize policy rates back to pre-Covid settings. We don’t expect them to go beyond that to try to squash high inflation as the costs to growth and employment would be too high. We see central banks living with inflation.

Directional views

Strategic (long-term) and tactical (6-12 month) views on broad asset classes, May 2023


Read details about our investment themes and more in our 2022 Global outlook.

Living with inflation


We expect central banks to carry on with normalizing policy. We see a reduced risk of them slamming on the brakes to deal with supply-driven inflation. Politically, it’s easier to blame inflation on the Ukraine war and argue that monetary policy can do little about it, in our view.

    • This means central banks are unlikely to come to the rescue to halt a growth slowdown by cutting rates. In addition, the risk of inflation expectations becoming unanchored has increased as inflation becomes more persistent.
    • We believe the cumulative response to rising inflation will be historically muted. DM central banks have already demonstrated they are more tolerant of inflation..
    • The Fed is poised to start hiking rates this week for the first time since the pandemic hit. The European Central Bank last week struck a hawkish tone, leaving the door open for a rate increase later this year. We expect it to adopt a flexible stance in practice, given the material hit to growth from higher energy prices.
    • Investment implication: We prefer equities over fixed income and remain overweight inflation-linked bonds.
Cutting through confusion


We had thought the unique mix of events – the restart of economic activity, virus strains, supply-driven inflation and new central bank frameworks – could cause markets and policymakers to misread the current surge in inflation.

    • We saw the confusion play out with the aggressively hawkish repricing in markets at start the year.
    • The Russia-Ukraine conflict has compounded the inflation picture. Yet we still think the response to inflation will be historically muted as central banks focus on getting policy rates closer to neutral.
    • So far the sum total of expected rate hikes hasn’t changed, even as markets have cooled expectations of higher rates in the near term.
    • Investment implication: We have tweaked our risk exposure to favor equities at the expense of credit.
Navigating net zero


Climate risk is investment risk, and the narrowing window for governments to reach net-zero goals means that investors need to start adapting their portfolios today. The net-zero journey is not just a 2050 story, it's a now story.

    • Sustainability cuts across multiple dimensions: the outlook for inflation, geopolitics and policy. The green transition comes with costs and higher inflation, yet the economic outlook is unambiguously brighter than a scenario of no climate action or a disorderly transition. Both would generate lower growth and higher inflation, in our view.
    • Risks around a disorderly transition are high – particularly if execution fails to match governments’ ambitions to cut emissions.
    • We favor sectors with clear transition plans. Over a strategic horizon, we like the sectors that stand to benefit more from the transition, such as tech and healthcare, because of their relatively low carbon emissions.
    • Investment implication: We favor DM equities over EM as we see them as better positioned in the green transition.
Alex Brazier
Deputy Head – BlackRock Investment Institute
Nicholas Fawcett
Macro Research – BlackRock Investment Institute
Meet the Authors
Jean Boivin
Head – BlackRock Investment Institute
Wei Li
Global Chief Investment Strategist – BlackRock Investment Institute