Ukraine Update

Petro Poroshenko

It was hoped that the high-level delegates meeting held in the Belarus capital, Minsk on August 26 might have yielded the de-escalation of tensions in the Ukraine. It seemed like an opportune moment, bearing in mind that the attendees could not have been more senior with Ukraine president Petro Poroshenko and his Russian counterpart Vladimir Putin arriving in Minsk for the crisis talks. A number of senior EU officials along with leaders from Kazakhstan and Belarus also attended the crisis summit. Their motives were clear; to defuse the skirmishes between the pro-Russian separatists and Ukraine's government forces and guided the two opposing sides towards a diplomatic solution.

Vladimir Putin

But regretfully, the Minsk summit did little to de-escalate the tensions in the Baltic, in fact it may have had the reverse effect of ratcheting up tensions between Russia and its former colony the Ukraine even further. Letting off some steam Russian president Vladimir Putin fired his rounds accusing the Ukraine and its Western supporters, of stalling efforts to reach a new cease-fire and open talks. Ukraine president Petro Poroshenko’s response was nothing more than pouring fuel on the fire. Poroshenko is now considering a provocative move to push back a law which prevents the Ukraine from joining North Atlantic Treaty Organisation (NATO). That would be like poking the bear in the eye. Think about it, would the US welcome Russian Mig fighter jets on its doorstep, in say Mexico!

Flag of NATO

Assuming the Ukraine actually decides to join NATO, a possible worst case scenario, then the Ukrainian crisis would take on another more dangerous dimension. Article 5 of NATO states that an attack on one member is an attack on all. In other words, Russian forces in the Ukraine would then be the catalyst to draw in other NATO European countries into the war to the defence of the Ukraine. Reluctant European leaders would probably tell their weary electorate, sorry but our hands are tied we have an obligation to defend our new NATO member ally, the Ukraine. So localised fighting in the Ukraine could in theory spiral into a European war with Russia. Once things go down that slippery slope it could even descend into a global war, with Russia calling on its allies. Again, this would be the worst case scenario and let’s hope that the situation doesn't implode on those lines.

However, the Ukraine crisis is again more prominent on the trader's radar, particularly following the dashed hopes of the Minsk summit bringing a de-escalation of tension in the region.

How will EU and US policy makers respond to the failed Minsk summit? If the answer is more sanctions on
Russia, which then leads to similar tit for tat profit whacking Russian sanctions on EU businesses, then that would not be a desirable outcome either. The EU economy is battling enough headwinds at the moment, liquidity problems, slowing and contracting economies and mass unemployment in the South. More sanctions are probably the least thing that EU policy makers and businesses want on their plate now. Russia is the European bloc’s third largest trading partner and already the fallout from Russian sanctions is making EU businesses nervous.

NATO member countries (orthographic projection)

For example, when it was released to the press in early August that Moscow was mulling over a proposal to ban western carriers from using Siberian air space for routes to Asian cities. European airline stocks unsurprisingly fell sharply. Air France, British Airways and Lufthansa all use Siberian air space for routes to Asian cities. Flightradar24, an aircraft tracking service, estimates that Lufthansa operated 162 flights that passed through Siberian airspace over the past seven days, while Air France had 133 and British Airways had 93. So any move to ban western carriers from using these Siberian routes would push up their fuel bills.

Moscow's embargo on food imports from the EU, as well as from the United States is hitting hard agricultural producers in the south. European agricultural trade with Russia was worth 12 billion euros in trade in 2013, this year the sector is bracing itself for huge losses, due to the Russian sanctions.

Luigi Negro, advisor to farmers in the Apulia region of Italy, said: “The economic blow we’ve received strengthens the resolve of our own producers, but, at the same time, it’s a cause of great concern as well.”

A trade union representing Spanish Catalonian crop growers and cattle ranchers staged a protest, demanding that the EU compensate them for the revenues lost as a result of the escalation of sanctions, which have closed the Russian market to them. Spanish farmers burned the EU flag in anger over Russia sanctions war. The EU has allocated €125 million to help farmers in the immediate aftermath. Finance group ING has estimated that the annual losses as a result of the blocking of the Russian market will amount to €6.7 billion a year, and could result in the loss of 130,000 jobs.

Furthermore, German utility E.ON posted a 12 percent drop in first-half profits, hit by a weakening economy in Russia, and said it was concerned about the impact of the Ukraine crisis on its most important foreign market.

So the effects of tit for tat sanctions over the Ukrainian crisis are biting. Moreover, the Ukraine is a conduit for Russian gas to central Northern Europe, if Moscow were to turnoff the gas supplies to the Ukraine that would cause a spike in energy costs which would be crippling for an already feeble EU economy.

JPMorgan's Alex Kantarovich, in a recent letter to clients, underscores the severity of the problem, “In the worst case scenario, now appearing more likely, severe pressure on stocks may extend. We believe that with the significant deterioration in the Ukrainian situation, markets may treat this as a Lehman-style shock."

Therefore, the Ukrainian crisis is starting to feature prominently on trader's radar again. Should the situation continue to deteriorate the adverse knock-on effects to businesses would be amplified, thereby hitting bottom line corporate profits. Consequently, that might act as drag on the European economy and that could then delay further those long anticipated UK interest rate hikes.