Sanctions loom for Russia

March 13, 2014

The European Union, as we exclusively reported yesterday, has agreed on a framework for sanctions against Russia, including travel restrictions and asset freezes, which goes further than many expected. The list of targeted individuals is still being worked on but will be ready for the bloc’s foreign ministers to look at on Monday.

Angela Merkel will speak to the German Bundestag about the standoff with Russia. Merkel has been cautious about imposing anything too tough as she tries to convince Vladimir Putin to agree to a “contact group” that would reopen communications between Moscow and Kiev. But yesterday she said measures would be imposed next week – after a Crimean referendum on joining Russia which the West says is illegal – unless diplomatic progress is made.

There is no sign of Vladimir Putin coming to the negotiating table and no question of western force being deployed. In Washington, Ukrainian Prime Minister Arseny Yatseniuk said his government was ready to negotiate over Moscow’s concerns for the rights of ethnic Russians in Crimea – a possible diplomatic avenue? The U.N. Security Council will discuss the crisis in an open meeting later.

Russia’s intervention in Crimea has focused minds in the EU on ending decades of dependence on Russian gas by developing its own energy supplies and pushing for greater access to U.S. resources. That will come up at next week’s summit of the bloc’s leaders. It’s clearly a long-term project but could be a hammer blow to the Russian economy if it succeeds.

Italy will dive into the bond market after Prime Minister Matteo Renzi presented a sweeping package of tax cuts, saying they would foster economic recovery without breaking EU budget deficit limits. Income tax will be reduced by a total of 10 billion euros annually for 10 million low and middle income workers which should give domestic demand a fillip.

Perhaps even more importantly, Italy’s lower house of parliament approved a new electoral law proposal presented by Renzi. It will now go to the Senate where it is likely to face some amendments but after that the country should be able to look forward to more stable governments in future.

Rome will try to sell up to 7.75 billion euros of four bonds with a maturity of three, seven, 15 and 30 years and is selling a 10-year inflation linked bond via syndication, its first for nearly three years, to raise a further 4.5 billion euros. Borrowing costs at a sale of one-year paper on Wednesday hit new euro lifetime lows so there is still no sign of pressure from the debt markets.

Ireland, having escaped its bailout, will hold its first bond auction since 2010 – a 10-year sale for up to 1 billion euros. Dublin is so advanced in its funding that it doesn’t really need the money but is keen to keep its hand in. Fourth quarter GDP and February inflation figures are also due.

European Central Bank President Mario Draghi, his right-hand man Benoit Coeure, and Bundesbank chief Jens Weidmann all speak today. They represent a pretty good cross-section of opinion within the central bank.

The ECB has forecast inflation to remain well beneath its “just below 2 percent” target all the way through 2016 but has dismissed the threat of deflation and took no policy action last week.

With interest rates close to zero, a cut will have little impact. We know there is a problem with a new round of cheap long-term money for  the banks since the ECB insists it would have to be lent on at a time that banks are deleveraging ahead of health tests later in the year. And Draghi killed the “non-sterilisation” of bond purchases pretty much stone dead by highlighting its limited effectiveness.

So it looks like an all-or-nothing approach – no action at all or full-on QE if deflation takes hold. The former is far more likely.

A committee of experts will hand a report to Spain’s Treasury on how to reform its tax system. The government has already promised income tax cuts for 2015, an election year, though it has also said they will initially be revenue-neutral.

The government will go public on Friday but it seems Mariano Rajoy is prepared to take a big electoral gamble – shifting the tax burden from jobs to consumption by lowering the burden on businesses but pushing up consumption taxes such as VAT.

The strategy would probably boost exports further, and help create jobs, but it could also hit domestic demand. Spanish retail sales fell at their fastest rate in four months in December, adding to evidence that a tentative recovery has yet to be supported by depressed consumer demand.

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