THE first few weeks after the Covid-19 outbreak hit the Wuhan province, China in late 2019, many people believed that it was just a normal flu, like the severe acute respiratory syndrome outbreak from 2000 to 2004 or the Middle East Respiratory Syndrome outbreak in 2012.
Then in March 2020, the worst happened when the coronavirus outbreak spread beyond the province and into every part of the world.
Before the outbreak, the global economy was in on a strong footing. The International Monetary Fund forecast that the global economy would grow by 3.4% in 2020. But the pandemic had forced growth to be downgraded to minus 4.4%.
The US economy was also expanding at a modest pace before the pandemic. Looking at the macro data, the unemployment rate was at the lowest point of 3.5% in February 2020, while inflation was modest, averaging around 2.3% in 2019.
Across the Atlantic, the UK economy was also expected to grow robustly despite Brexit. The unemployment rate was the lowest level at 4% in February 2020 and inflation was also modest, averaging at 1.3% throughout 2019. During the outbreak occurred, authorities were forced to implement the stay-at-home order to keep the healthcare system from being overwhelmed and flatten the infection curve.
The US and UK economies saw the worst jobless rate in history. Unemployment went up to 14.7% in the United States in April 2020. About six million people applied for unemployment insurance – the highest level recorded in post-war history. Both economies responded by expanding their fiscal policy stance and pushing interest rates to the lowest level possible.
In the United States, Congress approved the Coronavirus Aid, Relief and Economy Security Act that was worth US$2.3 trillion (RM9.68 trillion), around 11% of gross domestic product (GDP), that included grants, cash assistance and other assistance.
The Federal Reserve (Fed) also applied the same measure it took during the global financial crisis.
It slashed the Fed funds rate to almost zero per cent and reintroduced its large-scale asset purchases programme worth US$700bil (RM2.9 trillion).The UK government announced £59bil (RM327bil) of stimulus that supported households and businesses. From a monetary policy stance, the Bank of England slashed the policy rate to 0.10% and reintroduced the large-scale asset purchase programme of £450bil (RM2.5 trillion).
Both economies rebounded due to the measures. There were some hiccups along the way due to multiple variants that emerged, including the Alpha, Beta, and Delta.
The Omicron variant, which was more contagious, pushed confirmed cases to the highest level, where they peaked at 1.3 million for the United States and around 220,000 for the UK in mid-January 2022.
The bright side is that the vaccination programmes kept confirmed cases from spiking, despite some pushback on the programme.In the second half of 2021, the global economy rebounded, including the United States and the UK.
However, the economy had to deal with supply bottlenecks during this period due to the imbalance in economic recovery in different countries, where the vaccination programme was lagging.
Other issues include the shortage of labour, lack of raw materials and stringent government policies that delayed shipments.
However, price pressure continued to accelerate due to the imbalances in supply and demand. Even so, both economies were expected to continue to recover. The unemployment rate for the United States declined to 3.9% and the UK was at 3.9% in December 2021. This was the lowest level since the pandemic. Sadly, the recovery momentum was disrupted by Russia’s invasion of Ukraine in late February 2022. This led to two ramifications – higher commodity prices and further supply chain disruption.
Russia is an important producer for oil and gas at around 10.5 million barrels per day or 11% of global production. It is also a major producer of fertilisers, which are crucial for food production, making up a 14% share of global exports.
Ukraine was a major exporter of wheat, with some 8.5% global share.
In a swift retaliation, Western allies imposed a series of sanctions on Russia. They hammered not only Russia’s economy but had an unintended effect on the global economy through their trade exposure and higher commodity prices. This could dampen the economic outlook in the United States and Britain in two different ways.
Firstly, both economies could be affected via their trade exposure to both Russia and Ukraine. Based on the latest estimates, the US trade exposure to Russia was around US$34.9bil (RM147bil), where the most imported commodities are petroleum-related products, iron and minerals, and fertilisers.
Meanwhile, Britain’s trade exposure to Russia was around £11.6bil (RM64bil). The most traded commodities included precious metals, petroleum-related products, and minerals.The second way is via higher commodity prices. These countries are net importers of oil, meaning energy prices are highly dependent on global trading prices.
Before the invasion in Ukraine, commodity prices were already high. Oil prices were trading around US$93.69 (RM394.48) on average between January 2022 and February 2022. After the invasion, oil jumped US$110 to US$120 (RM463 to RM505) per barrel.
This means that energy prices for these two economies are expected to remain high until the situation in Ukraine improves. Apart from oil, food prices are expected to rise due to these factors.
According to the Food and Agriculture Organisation, prices for vegetable oils, cereal and dairy, which were already high, are expected to climb further due to potential shortage.
Higher prices of energy and food will stem the appetite for spending, and investment plans.
This is where stagflation could enter into the picture. Stagflation derives from two different words; “stag” from stagnant growth, referring to very low, zero or negative economic growth. The word “flation” comes from high inflation, meaning prices for goods and services are too high.
Stagflation is a rare event, and the last time it occurred was back in the 1970s, as a result of the oil embargo by Saudi Arabia.
The US economy then saw inflation peaked at 13.5%, and the Bureau of Labour Statistics estimated that around 2.3 million people lost their jobs. The UK economy was also affected, where the economy shrank by 0.8% and inflation surged to more than 20% in 1975.
Stagflation also contradicts the economic theory, where generally, higher economic growth should translate to higher inflation due to stronger demand from consumers.
Looking at the evolving situation currently, both sides seemed willing to resolve the matter diplomatically, although most of their demands were rejected by the other.
Conflict may linger
We foresee that this conflict could prolong with the possibility of further escalation with greater involvement by the North Atlantic Treaty Organisation and ultimately, a full-fledged nuclear or chemical war.
Due to its relatively higher dependency on Russian oil and gas, the UK economy is poised to suffer the impact much more than its US counterpart.
Higher prices may translate to lower demand and added with the policy normalisation path that central banks may take this year, there will be a greater pressure on the demand side. With the risks of further escalation in the geopolitical tension, we need to raise the risk premium in projecting both economies’ outlook. Despite the muted Omicron outbreak locally, China’s move to put Shenzhen and Shanghai under lockdown to contain its surging Covid cases could affect the global supply chain with major manufacturers and suppliers operating under restrictions. As such, we cut our UK’s GDP projection to 3.6% from (4%), and the US growth to 3.5% from (3.7%).
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