Four months after the start of hostilities in Ukraine, some initial lessons can be drawn: the conflict, which is set to last, has already upset the global geo-economic balance, triggering new tectonic movements whose repercussions, undoubtedly significant, are still difficult to discern and circumscribe - let alone quantify. In the short-term, as we explained recently, the war is exacerbating tensions in a production system already severely damaged by two years of pandemic and heightening the risk of a hard landing for the world economy. While the latter was seemingly under the threat of stagflation a few weeks ago, the change in tone of the main central banks, faced with a continuous acceleration of inflation, has resurrected the prospect of a new recession - particularly in the advanced economies.

Although the extremely high volatility observed in March/April has given way to a relative stabilisation - on average - of commodity prices, the latter are still very high (food and energy in particular), and will probably remain so until global economic growth slows down significantly. The room for manoeuvre on the supply side is increasingly narrow, as export restrictions on food products accumulate, while Western sanctions (and Russian counter-sanctions) now target all forms of energy supply. A sustained or enhanced transmission of input price increases to the prices of goods and services (which is still in its infancy in some countries/sectors) seems inevitable, especially as wage pressures, given the current context, will intensify. In other words, the risk of stagflation has grown considerably, and the first signs of it can already be observed.

Accordingly, the ECB has gradually tightened its stance, following in the footsteps of the U.S. Federal Reserve and the Bank of England, to the point of pre-announcing its future rate hikes for the year-end. Like the other major central banks (excl. Bank of Japan), the ECB has no other choice, within the strict framework of its mandate, than to tighten its guard significantly, despite the fact that this could trigger a brutal slowdown in activity and rekindle fears of a fresh European sovereign crisis. That being said, the ECB immediately proceeded to dispel these fears by reaffirming its intention to avoid any excessive fragmentation of the financial markets.

Nonetheless, our central scenario does not assume these extreme developments: consistent with the current consensus, economic activity is expected to decelerate gradually, dragging consumer prices down with it. More generally, we believe that a soft landing for the global economy is still possible, although much more unlikely than at the beginning of the year: the ridge that could avoid both recession and stagflation is getting narrower and the temptation to trigger the former to avoid the latter is growing. The price to be paid, in the event of failure, will be particularly high, as the policy mix would become particularly unclear and destabilising, between monetary austerity and budgetary compensation. In fact, there is no reason to exclude the possibility that by trying to avoid one at the cost of the other, we end up with both.

In this complex international environment, we downgraded 19 countries, including 16 in Europe - Germany, France, the United Kingdom and Spain in particular - and upgraded only 2 (Brazil and Angola). On a sectoral basis, the number of downgrades this quarter (75 in total, vs. 9 upgrades) highlights the gradual spread of these successive shocks across all sectors, both energy-intensive (petrochemicals, metals, paper, etc.) and those more directly linked to the credit cycle (construction). As the horizon continues to darken, the risks are naturally bearish and no scenario can be ruled out.

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