Nearer to the brink

April 25, 2014

De-escalation?  Forget it. Ukrainian forces killed up to five pro-Moscow rebels in the east yesterday and Russia launched army drills near the border in response.

The big question now is whether Russian troops will cross into eastern Ukraine following a constant stream of warnings from Moscow about the security of Russian speakers there.

Foreign Minister Sergei Lavrov is expected to have a telephone conversation with U.S. Secretary of State John Kerry, following last week’s Geneva accord which aimed to pull things back from the brink. Kerry said yesterday that Russia’s “window to change course is closing” and U.S. President Barack Obama said tougher sanctions were ready to go. There is no question of Western military intervention.

According to our sources, Obama – on an Asian tour – will hold a conference call with British Prime Minister David Cameron, French President Francois Hollande, German Chancellor Angela Merkel and Italian Prime Minister Matteo Renzi.

The EU has circulated a document spelling out possible future sanctions and we broke news yesterday on an initial foray targeting financial institutions in Crimea.
Russia’s central bank holds a policy meeting and is expected to keep interest rates at 7 percent with inflation still too high for comfort and in spite of signs that an already faltering economy is now being hit by Western sanctions that could soon be escalated.

Kerry said Moscow risked making an expensive mistake, an assessment that carries some weight. Russian President Vladimir Putin said the impact on the Russian economy has so far not been critical, but he did admit that some damage has been inflicted even by the first round of measures.

Despite concerns in the Kremlin about the state of the economy, Central Bank Governor Elvira Nabiullina has said the bank does not plan to cut its key lending rate until its June meeting at the earliest, as inflation concerns remain. The weaker the rouble gets, the higher inflation is likely to be.

The Russian Economy Ministry has said growth could significantly undershoot its 1 percent forecast this year if the recent trends continue. Many are talking of recession and the economy suffered more than $60 billion in capital outflows in the first quarter, the same as for the whole of 2013. The World Bank believes this year’s total could reach $150 billion.

S&P has just cut Russia’s credit rating by one notch to BBB-, predicting a continuation of those financial outflows. That puts it one notch above junk status.
Friday has become ratings day. Fitch has already moved to upgrade its outlook on Italy’s BBB+ rating to stable from negative, a fillip for Renzi. The agency highlighted benign funding conditions on the bond market and the government’s structural reform agenda while noting that a return of political turmoil could wipe out those positives.

Fitch is also due to opine on Spain today and S&P has affirmed France’s rating at AA with a stable outlook, citing the government’s efforts to improve competitiveness and reduce the public deficit – a vote of confidence after Paris this week produced growth and deficit forecasts which its own national watchdog said looked optimistic.
President Francois Hollande plans to deliver 50 billion euros of spending cuts to fund consumer and business tax cuts.

Positive Slovenia, the prime minister’s party, will elect a new leadership. Prime Minister Alenka Bratusek is expected to be re-elected as the president of the party but if she fails to win the vote her centre-left government is likely to collapse, prompting early elections in the autumn.

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