EU cuts off Russian banks, puts ball in Moscow’s court

July 30, 2014

Russia's President Vladimir Putin talks to reporters during a meeting in Brasilia

True to its word, the EU agreed sweeping sanctions on Russia yesterday, targeting trade in equipment for the defence and oil sectors and, most crucially, barring Russia’s state-run banks from accessing European capital markets. The measures will be imposed this week and will last for a year initially with three monthly reviews allowing them to be toughened if necessary.

There was no rowing back from the blueprint produced last week – having already agreed to exempt the gas sector – and the United States quickly followed suit, targeting Russian banks VTB, Bank of Moscow, and Russian Agriculture Bank, as well as United Shipbuilding Corp.

That is important. Both sides are striving to shut down alternative sources of capital for Russia’s financial sector although there has already been some reaching out to Asia. Gazprombank held a two-day roadshow with fixed-income investors in Seoul last week.

Shares in Russia’s second-largest bank VTB have opened down 3 percent while the broader stock market and the rouble were stable. Russia’s central bank has said it will support the country’s banks if needed. With nearly $500 billion in FX reserves it could clearly do so for quite some time.

Previously Europe had imposed sanctions only on individuals and organisations accused of direct involvement in threatening Ukraine, and had shied away from wider “sectoral sanctions”. But the shooting down of the Malaysian airline changed the political calculus.

EU ambassadors also signed off on a new list of Vladimir Putin’s associates and companies that will face asset freezes and visa bans. The list will be published today, adding to the 87 people and 20 organisations already hit.

The big question now is how Moscow reacts. If Vladimir Putin cuts off the secessionist rebels in eastern Ukraine, having made such a big deal of defending them, he will look weak. But step up efforts to support them and the West could tighten the screw further.
Both routes could eventually lead to his sky-high popularity ratings at home waning. As President Barack Obama said last night, a weak Russian economy is about to get even weaker.

The EU aim is to inflict maximum financial damage on Russia for the minimum pain at home. By exempting gas supplies and allowing France to complete a naval helicopter carrier contract with Russia, by removing existing deals from the sanctions, they have largely done so.

There will be some impact for the EU economy as well, not least London’s financial centre, although the British economy is better equipped to take a bit of a knock than most of its continental peers. Despite deep trade links, the biggest impact is likely to be on business confidence – already showing up in surveys – given the lurking fear that Europe’s gas supplies could be affected. However, it seems unlikely that Russia could bear the loss of revenue by turning the taps off for long.

It’s a big data day. German inflation figures for July will give the latest indication of the lack of price pressure with the euro zone figure to follow on Thursday. The year-on-year German inflation rate is forecast to fall to 0.8 percent and could help push the number for the currency area as a whole down from 0.5 percent.

The Bundesbank has taken the unusual step of saying wage deals in Germany are too low –  a message reinforced by its chief, Jens Weidmann, overnight. None of that will force the European Central Bank to act (it meets next week) to act yet. It is still waiting to see what impact its June interest rate cuts and offer of more long-term cheap money to banks might have.

Opposition to QE remains high and one problem for the ECB will be how to remain in ultra-stimulative mode once U.S. interest rates start to rise. The Federal Reserve concludes a policy meeting on Wednesday. It is on course to end its money-printing programme in October and, while no tightening is expected before mid-2015, any comment that adds to the growing realization that it is coming could start to have an impact. There is little chance of euro zone long-term interest rates decoupling from U.S. ones.

We also get a slew of GDP data, from Spain, Sweden and Belgium. The UK economy continues to romp ahead but on the continent there are signs of a new slowdown. The Bundesbank now forecasts no Q2 growth at all and though flash PMIs showed the euro zone economy rebounding in July, that largely came at the cost of companies cutting prices further, thereby pushing inflation lower still.

Spain is one brightening spot. The Bank of Spain has predicted quarterly growth of 0.5 percent in the second three months of the year, not stellar but healthy and adding to 0.4 percent growth in Q1.

Artur Mas, head of the Catalan regional government, will meet Prime Minister Mariano Rajoy today for the first time in more than a year to discuss a deadlock over a non-binding referendum on Catalonia’s status within – or beyond – Spain.

The consensus of economists’ forecasts is for quarterly Swedish growth of 0.5 percent and 0.3 percent in Belgium. Italy will auction up to 7 billion euros of a range of bonds.

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