War, what is it good for?

Last week marked the first anniversary of Putin’s full-scale invasion of Ukraine. The worst war in Europe since 1945 has inflicted immense suffering on the people of Ukraine and created a humanitarian crisis.

Ukraine and its supporters in the free world have risen to the challenge better than expected. However, European nations that have withstood the ravage of the global Covid-19 pandemic are now having to address energy security and under-investment in defence. There has been a resurgence in NATO with Finland and Sweden looking to join the alliance.

The war has had global ramifications with the imposition of sanctions against Russia driving a spike in food and energy prices. This, in turn, has impacted households and investors. The mild winter weather has proved to be something of a blessing with energy prices falling back below pre-invasion levels, but food prices remain elevated.

What is our take on the short-term and long-term scenarios of the war?

At the current time, Russia probably does not have the military capability to conquer Ukraine and install a puppet regime in Kyiv. However, Ukraine will need far more powerful weapons in greater quantities to take back occupied territory. At the moment, with the West continuing to re-arm Ukraine, it looks as if the war of attrition could drag on longer without a decisive breakthrough this year.

The long-run is a different matter. Russia has major advantages with a larger population and while the war is being fought solely in Ukraine, the country’s infrastructure is being steadily destroyed. On the other hand, the Ukrainians continue to offer fierce resistance and the West is arming them with better quality weapons. The slow poison of sanctions will continue to impact the Russian economy, but in the short-term this has been partly countered by China and India buying cheap Russian energy, as well as some Middle Eastern countries allowing Russians to evade sanctions. The IMF is actually forecasting that the Russian economy will outperform the UK in 2023!

What will China do? President Zelensky plans to meet China’s leader Xi Jinping to discuss Beijing’s peace plan to end the war. However, President Xi Jinping is an ally of Putin, but the war impacts China’s key European export market. Meanwhile, the US election in November 2024 could pose a risk to Ukraine and NATO cohesion, given some Republicans have challenged the scale of US military support.

The greatest risk is still that Putin resorts to the use of tactical nuclear weapons or a nuclear power plant is severely damaged. While Putin has continually chosen the path of escalation, he has nonetheless, so far resorted to conventional weapons.

All we know for sure at the present time, is that war is good for absolutely nothing. Ukrainian President Zelensky said recently ‘We understand all wars finish at the negotiating table.’ Putin needs to find a face-saving exit plan.

What have we been watching?

Another week with interest rate and inflation expectations dictating the path of equity markets and the return of ‘good news is bad news.’ Better than expected business activity data in the UK and US was supportive of the argument for a shallower global recession but equally raised concerns about wage growth and how central banks might react.

President Joe Biden marked the anniversary of Russia’s invasion of Ukraine with a visit to Kyiv and a pledge of an additional $500m of weapons. In his State of the Nation address, Putin said he was pulling out of the New Start Treaty, the last remaining nuclear weapons deal between Russia and the US.

Are we seeing a slightly rosier picture for UK public finances? UK government finances revealed an estimated surplus in January of £5.4bn, compared to market expectations of a deficit of almost £8bn. January tends to be a benign month for public finances due to self-assessed income tax and corporate tax payments. Chancellor Jeremy Hunt has made it clear that there will be no room for significant tax cuts. However, the latest data may provide some ‘wriggle room’ ahead of the Budget on 15^th March. The Chancellor will also be helped by the fall in energy prices with the Institute of Fiscal Studies expecting the cost of support to be some £11bn lower than originally envisaged.

The ’flash’ UK PMI business activity indicator for February was ahead of expectations with a rise from 48.5 to 53.0. The data is encouraging in that it suggests a shallower recession is possible in the first half of this year. However, firms have signalled that they have plenty of pricing power and are passing on the recent gains in wages. This could be a problem for the Bank of England and counters the more ‘dovish’ picture following the lower January inflation reading. Reflecting this, Sterling briefly edged up to $1.21.

The Eurozone ‘flash’ PMI business activity indicators suggested growth at a 9-month high with a composite reading of 52.3

The ‘flash’ US composite output index covering both manufacturing and services increased to 50.2 in February from 46.8 in January. This is the second monthly improvement, exceeding the 50.0 mark which signals expansion for the first time since June. The manufacturing sector is still in contraction with a reading of 47.8 but the service sector jumped from 46.8 to 50.5 – an 8-month high. The survey data underscores the upward driving force on inflation has now shifted to wages amid a tight labour market. The minutes of the last Federal Reserve (Fed) meeting underlined the determination of committee members to address high inflation, despite the move to a slower pace of interest rate hikes. US interest rate futures have are forecasting almost 5.5% from the current 4.75% with no cuts in 2023. The January PCE deflator – the Fed’s preferred measure of inflation came in ‘hot’ at 0.6% or 5.4% annualised.

Japan’s ‘flash’ manufacturing PMI activity indicator slipped to a 30-month low in January but this was countered by positive news from the service sector, where activity recovered to an 8-month high. Meanwhile, Japan like other countries, is seeing an increasing number of demands for wage increases. Toyota and Honda have just agreed a 5% pay rise, marking the biggest rise since 1990 and above Japan’s rate of inflation.

Brent oil dropped to $83 on mild weather and US interest rate considerations. Meanwhile, inspectors from the International Atomic Energy Agency discovered enrichment levels of 84% at Iran’s nuclear sites, just 6% short of the threshold for acquiring a nuclear weapon. This increases the risk of further tension with Israel or more western sanctions.

Finally, thank goodness for the recent mild weather and falling gas prices. Cornwall Insight are now forecasting a typical UK household energy bill to drop back to just over £2,150 in July compared with the current £2,500, after the £400 government discount. Will we at last be able to afford to switch on the light at the end of the tunnel?

Read Last Week’s Alpha Bites – The Art of War

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War, what is it good for?

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