(Reuters] Christine Lagarde of European Central Bank warned about “geopolitical storms” over Europe’s economy as a result of possible fallout from tensions between Russia, the West and Ukraine.

The impacts of rising food and energy prices, economic sanctions and damage to investor confidence could have wide-ranging and difficult to quantify consequences. Here are key variables and vulnerability.

WHAT IS THE LIKELY INFLATION IMPACT?

A conflict of any kind, however small, could cause fuel price and food inflation immediately and rapidly.

According to EU data, 41.1% of the EU’s imports of Russian gas and 27% from Russia are purchased by EU countries. Any restriction on supplies will quickly result in higher energy costs. This would have ripple effects on the economy, causing higher fuel and heating bills as well as more expensive transport and energy for businesses.

Also, food supply would likely suffer. Higher gas costs will likely cause a rise in all crop prices. A separate issue is that Ukraine exported more than 33 million tonnes of grain in 2014, so any disruptions there could reverberate around the world, including Europe.

Bank of America Securities, NYSE: Securities says that an escalation of inflation in the euro area could drive it up to 4% per year by 2022.

AND ON INVESTMENT AND TRADE?

    If Russia decided to stop all imports from the EU, it would affect the 80 billion euros worth of goods which the EU exports to Russia annually, worth 0.6% of EU GDP.

This EU exports mainly include cars, machines, chemicals, and made goods. Germany, the largest EU country, is Russia’s top exporter and importer. The Netherlands, Poland and Italy also trade in large quantities.

European companies would eventually seek out alternative partners for trading, just as many have since 2014’s confrontation with Crimea. Russia is now roughly half the export market for eurozone members.

    The EU is also the largest foreign investor in Russia with total direct investment of 311.4 billion euros in 2019. Russian investments in the EU total 136 billion euro. It all depends on how severe any counter-sanctions or sanctions are. Some, but not all, of the European presences in Russia may be affected.

    “On paper it is a lot, but this is only a small fraction of overall foreign FDI of EU companies,” said Daniel Gross, head of the CEPS think tank in Brussels, who added he saw little risk of Moscow wanting to expropriate plants run by EU companies because of the complexities entailed in running them.

What is THE EXPECTATION FOR THE EURO ZONE ECONOMY IN OVERALL?

However, it is clear that this would be a negative outcome. The household’s purchasing power would be reduced and confidence eroded by higher energy and food costs. Investments would fall quickly, and consumption would increase rapidly.

Last week’s ECB Lagarde stated that “the geopolitical cloud over Europe would definitely have an effect on energy prices” and that it could also cause an increase in investment and consumption.

Furthermore, because high energy prices adversely affect lower-income families, it is likely that governments will introduce subsidy measures which would increase the pressure on existing state funds already stretched by support for pandemics.

A Bank of America study found that an increase would expose Europe to 0.5% of its output through the impact on private consumption. Although many people have saved a lot during the pandemic and have some buffers, they have seen their fuel costs rise sharply.

What would the ECB do?

An inflation spike caused by conflicts would not cause the ECB to tighten its policies. The ECB doesn’t look at short-term volatility as policy only works for 12-18months.

Nevertheless, with inflation currently at a record-breaking 5.1%, and the ECB set to dewind stimulus over the coming months; a conflict would bring about an inflation spike and public pressure for the bank to move faster, even if this made economic sense.

“There’s not much that monetary policy can do to influence energy prices,” Neil Shearing at Capital Economics said.

While a rise of energy prices may increase inflation over the near term, all things being equal the squeeze on real incomes will be disinflationary in the long term.”