The global markets are painting a grim picture, and unfortunately, they appear to be right. We’re facing a period where things will likely worsen before they improve. The crucial question on everyone’s mind is: how bad will it get, and how does this current energy crisis stack up against previous shocks?
While significant and deeply concerning uncertainties persist, a historical template can help us contextualise the present situation. Looking back to the aftermath of Russia’s invasion of Ukraine four years ago provides a valuable benchmark. In essence, the economic fallout from the current conflict is anticipated to be broadly comparable, assuming a relatively swift resolution. However, if the war drags on through the summer, the repercussions will undoubtedly be far more severe than those experienced in 2022.
The silver lining is that if the conflict ends soon and a lasting ceasefire is established, the global economy as a whole should be able to navigate these turbulent waters in decent shape. The outlook for the United Kingdom, however, remains a separate and more complex matter.
A Look Back: The 2022 Energy Shock
Let’s take a step back to four years ago. Europe was gripped by genuine fears of gas shortages that could leave the continent freezing through winter. Russia was a dominant supplier, providing nearly half of the EU’s gas imports and a quarter of its oil. The prospect of widespread energy deprivation loomed large.
Ultimately, Europe managed to scrape by. This was partly due to continued, albeit reduced, gas imports from Russia and a significant increase in liquefied natural gas (LNG) purchases from other global suppliers. However, this scramble came at a steep price. Energy prices skyrocketed, impacting countries like the UK, which did not directly import gas from Russia. For the UK, the shockwaves were felt through higher gas bills and, consequently, increased electricity costs, given the nation’s reliance on gas-fired power generation.
Furthermore, motorists faced higher petrol and diesel prices as global oil benchmarks, such as Brent crude, surged from around $70 a barrel to over $100 – a price trajectory mirroring recent trends.
Navigating 2022 proved challenging. The dramatic spike in gas prices had a ripple effect on food costs, as natural gas is a fundamental component in fertiliser production. Inflation soared into double digits, inflicting considerable economic pain. Despite these hardships, the situation did not escalate into a full-blown catastrophe. Economic growth, which had been on a recovery path post-pandemic, stalled in 2023. However, a recession was averted, and unemployment rates remained relatively low.
The Current Crisis: Similarities and Differences
The current unfolding events are not an exact replica of the 2022 scenario. Some aspects of the present crisis are less favourable, while others offer a degree of mitigation. The Middle East commands a far larger share of global oil and gas production compared to Russia. The spectre of oil prices reaching $150 a barrel, once a terrifying prospect, is now a tangible concern. Moreover, the squeeze on gas supplies is already beginning to impact fertiliser prices, echoing the past.
However, a crucial difference lies in inflation forecasts. While the immediate impact on energy prices is evident, there’s a notable absence of predictions suggesting a surge in inflation comparable to the 11% peak witnessed in October 2022. Current top-end estimates place inflation around the 5% mark.
Emerging Concerns: The UK’s Financial Vulnerability
What is more concerning, however, is the UK’s weakened financial standing compared to four years ago. While the budget deficit remains similar, hovering around 5% of national output or gross domestic product (GDP) – a reflection of ongoing post-pandemic recovery efforts – the cost of financing the national debt has escalated dramatically.
Interest rates were already on an upward trajectory throughout 2022, exacerbated by the volatile period of the Liz Truss premiership in September. Yet, by the end of 2022, the ten-year yield on government bonds, or gilts, stood at approximately 3.5%. Fast forward to Friday afternoon, and this figure has surpassed 5%. This represents the highest level since 2008, during Alistair Darling’s tenure as Chancellor, and significantly exceeds the peak reached during the Liz Truss crisis. Furthermore, it is the highest among all major developed economies.
The situation becomes more concerning when examining inflation trends. In December 2021, preceding the Russian invasion, UK inflation stood at 5.4%. While this was lower than in the US and only slightly above Germany, it was higher than other G7 nations. By last year, UK consumer prices had risen by 3.4%, a figure considerably higher than the rest of the G7 countries.
The financial markets are signalling their anticipation of further interest rate hikes, rather than reductions.
Navigating the Storm Ahead
This period promises to be challenging. The ultimate severity will hinge on the duration of the ongoing conflict and the extent of damage inflicted upon oil and gas production in the Middle East, encompassing nations like Iran, the Gulf States, and Saudi Arabia.
Successfully weathering these difficult times necessitates a government with sound financial footing. It is also significantly easier to mitigate the impact of elevated energy costs when underlying inflation is low. Regrettably, the United Kingdom can currently claim neither of these crucial advantages.
