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The ongoing conflict in Ukraine

  • Rising inflation
  • Rising base interest rates


In March, markets continued to be marked by the ongoing conflict in Ukraine. The US S&P 500 index gained 3.6%, while in Europe the development was mixed and oscillated around zero mainly due to declines in Germany, Austria or Italy. Growth in the CEE region (+6.5%) benefited from the higher weighting of energy and retail titles and utilities. The banking sector posted losses due to exposure concerns on Russia. However, global emerging markets ended in losses (-2.5%), mainly due to China. Government bond prices fell sharply in the US and Germany under the weight of rising inflation and the outlook for monetary policy. Energy and commodity titles played an important role in the recovery in equities, benefiting from rising commodity prices due to disrupted supply chains and sanctions against Russia.

The US Fed started raising interest rates in March, in a first move of 25 basis points, with a statement that further moves could be much more significant. The market is beginning to speculate that the ECB could also raise interest rates several times this year. The consequences of the war in Ukraine have proved less fatal for the US economy, which has so far coped surprisingly well with the cost shock. The US benefits from its position as a large commodity producer, for which high commodity prices mean “just” a redistribution of growth between different sectors of the economy. The good picture is also underlined by the continuing recovery in the labour market, where an additional 431,000 new jobs were created in March and the unemployment rate fell to its pre-forecast lows.

Crown government bond prices also fell as data for February showed inflation at 11.1%. The CNB raised the repo rate by 50 basis points to 5.00% in late March and further monetary tightening may follow in May. Although it is clear from the statements of individual board members that some of them are beginning to perceive the risk of high inflation (mainly fuel, energy and food prices) to economic growth, concerns about inflation risks still prevail. According to the current forecast, the CNB will no longer raise the key interest rate so quickly. It could reach its peak somewhere in the third quarter of this year at around 6%, with a view to starting to cut the interest rate during the first or second quarter of next year, depending on the market situation. Central European currencies weakened in early March and the CNB intervened in the foreign exchange market, but by the end of the month the koruna had strengthened to below 24.50 per euro.

Eurozone markets were processing the initial shock caused by the war in Ukraine. Geopolitics is a huge source of uncertainty for both the economy and the financial markets. The stagflationary nature of the whole situation (deteriorating GDP outlook, upward pressure on inflation, especially through energy and food prices) is also a headache for central banks. For the time being, the need to prevent inflation expectations from rising, and hence the need to tighten monetary policy, has dominated central bankers’ thinking. But in the case of the ECB, caution remains part of the approach.

COVID is once again closing the economy in China. The reaction of developing economies and markets to the current crisis has been relatively muted. Most of them are commodity producers and the current high prices are good for them. Yet, we have seen a “loss of momentum” in growth in China, where sentiment has fallen to post-covariance lows. However, this was helped by the consistent continuation of the “zero” tolerance policy towards covide leading to partial closures in key economic zones. Thus, among the biggest losers of the conflict is primarily Russia, whose bonds and equities have de facto disappeared from global markets and whose economy has entered recession.

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