As the global economy began to recover from the pandemic and remained fragile, the Russian invasion of Ukraine introduced a fresh shock tied to geopolitical factors that had not previously manifested in such intensity. The world faced this pressure since the early 2000s, with armed conflict becoming an ongoing reality best described as geopolitical risk. This term covers threats linked to clashes between governments or high-tension situations that can destabilize economies. The war in Ukraine, along with the subsequent policy responses and sanctions, awakened geopolitical risk and its potential to disrupt almost every nation, except perhaps raw material producers.
Inflation surged to its highest levels since the 1970s and continues to be shaped by the dynamics of inflation, disposable income, growth, and job markets. The supply shock arrived as inflation was already elevated due to the post-lockdown resurgence in demand and strains within transport and distribution networks. The pandemic and the Ukraine conflict exposed the fragility of logistics chains, revealing how quickly they can fail to adapt to rapid shifts in demand and patterns of consumption.
Monetary policy now sits at a crossroads between urgent action and the need for correction, aiming to avoid stifling growth that remains uneven and fragile. The debate centers on when to begin withdrawing stimulus and whether reference rates should be adjusted more gradually to balance short-term needs with longer-term stability.
Geopolitical risk reemerges as a factor adding uncertainty to both consumption and investment decisions. Inflation, persisting longer than expected, erodes the real value of money and shapes the path of monetary policy. Current CPI readings in many countries exceed early forecasts, with knock-on effects on food prices and the broader inflationary process, even when energy and unprocessed food are excluded.
In the Eurozone, price dynamics have shown persistent weakness, with May posting an average uptick of about 0.8 percent. If such momentum persists, it could translate into a challenging annual growth rate near the ten percent mark. This inflation acceleration touches all sectors and influences how economic agents approach long-term planning, often leading to heightened risk aversion. Policymakers within the European Central Bank may face pressures to tighten further as inflation remains unexpectedly persistent, even as some voices argue for a more measured approach to avoid stifling activity.
Wage dynamics in the Eurozone have also shifted, driven by labor shortages in several sectors, especially in northern European economies. Early 2022 data show wage growth around 2.8 percent, the strongest in over a decade, with Germany and Belgium seeing increases above four percent. While higher wages help preserve purchasing power, they also raise the possibility of a price spiral, as employers pass higher labor costs onto prices and inflation remains elevated. The result is a cycle where wage growth boosts inflation, and inflation necessitates further wage adjustments.
Recent analyses from institutions such as the Bank for International Settlements, the European Central Bank, and policy think tanks in the United States indicate that profit margins for many firms are not just absorbing cost increases but expanding in some sectors. This trend reflects the uneven distribution of the burden when coordination to share costs remains limited. Without a broader agreement to allocate costs fairly, inflationary pressures could intensify, prompting stronger monetary responses with potential downside effects on economic activity and employment.