Nearer the brink

September 1, 2014

A man walks past cutting boards, that have been painted with images of Russia's President Vladimir Putin, at a street store in the center of St. Petersburg

Ukraine is nearer the brink with Russian forces now pretty clearly operating over the border. The past week has seen Ukrainian forces flee in the path of a new rebel advance which Kiev and its western allies says has been directly aided by Moscow’s forces.

Russian President Vladimir Putin called on Sunday for immediate talks on “statehood” for southern and eastern Ukraine, though his spokesman tried to temper those remarks, that following an aggressive public showing in which Putin compared the Kiev government to Nazis and warned the West not to “mess with us”.

The deputy leader of the breakaway east Ukrainian region said he would take part in talks with representatives of Moscow and Kiev in Minsk today but did not expect a breakthrough. Russian foreign minister Lavrov is out saying the Minsk talks will aim for an immediate ceasefire without conditions although he also said Ukrainian troops must vacate positions from which they can hit civilian targets. Meanwhile, eight Ukrainian seamen have been rescued, two are still missing, after a patrol boat was sunk by artillery.

Despite some vacillation at an EU summit on Saturday, there seems no way that Europe and the United States can avoid tougher sanctions to halt what they say is direct Russian military involvement in Ukraine.

One of the great imponderables of this crisis has been whether economic pain could bring Putin to heel or whether he felt free to act given the zero chance of any military intervention by the West, notwithstanding the call by U.S. lawmakers on both sides of the political divide on Sunday to send arms to Kiev.

Existing sanctions are clearly hurting the economy – the rouble has plumbed record lows as capital flees or shuns the country – but there will be a price for the EU too as many of its economies falter. Some in the bloc would be hugely vulnerable if Russia cut off supplies of energy although such a move would cost Moscow dear in terms of lost revenues.

The EU summit threatened Russia with new trade sanctions if Moscow fails to start reversing its action in Ukraine but divisions among the leaders left the timing of any measures uncertain despite a briefing by Poroshenko who warned “full-scale war” was imminent if Russian troops continued an advance in support of pro-Moscow rebels.
As always, the person to listen to is Germany’s Angela Merkel. She said new measures would be ready within a week – focusing again on banking, energy and defence – and said Putin must act to avoid them.

Merkel, Barack Obama and many others will attend a NATO summit in Wales later this week. That looks like a big moment. NATO Secretary-General Anders Fogh Rasmussen holds a pre-summit press conference today.

The appointment of Federica Mogherini as the bloc’s foreign policy chief will have been noticed in Moscow. Italy is particularly reliant on Russian gas and Mogherini was viewed with suspicion by eastern members of the EU as being soft on Russia. Balancing that, Polish premier Donald Tusk’s move to become European Council president puts a man with strong credentials in opposing Russian expansionism at the EU’s top table.

One interesting aside is that David Cameron, having miserably failed to stop Jean-Claude Juncker becoming European Commission president, managed a rare moment of acuity in EU diplomacy by putting Britain’s weight behind Tusk’s candidacy for the other top job. Tusk responded that he was prepared to compromise on British concerns to keep the country in the EU.

Europe’s resolve to face down Putin is inextricably linked to the state of its economies – Italy is back in recession, France is flatlining and even Germany contracted in the second quarter.

With the European Central Bank’s policy meeting looming on Thursday, today’s manufacturing PMI surveys from across the currency bloc will command close attention for signs that the third quarter has shown any improvement. Such evidence has been thin on the ground in recent weeks and euro zone inflation is creeping ever closer to zero.
More tit-for-tat sanctions with Russia, which have already had a marked downward impact on euro zone business confidence, are hardly going to help matters. That doesn’t necessarily means the ECB will act this week – though it will produce its latest economic forecasts which will presumably have to factor in yet lower growth and inflation – but movement is clearly afoot.

Exhibit A was Mario Draghi’s recent speech in Jackson Hole where he said it would be helpful if fiscal policy began to support ultra-loose monetary policy – a dramatic departure from the ECB’s mantra that euro zone governments had to focus on cutting debt.

The new deal would seem to be that the ECB will do whatever it can (though whether that stretches to QE remains to be seen) and governments can now spend as long as they press on with structural economic reforms in areas such as the labour market, pensions and the taxes and bureaucracy hampering business.

That looks very similar to Japan’s “three arrows” of aggressive monetary and fiscal stimulus underpinned by structural reforms and is close to the strategy urged by France’s Francois Hollande and Italy’s Matteo Renzi, though both are struggling with the many vested interests in their respective countries who oppose reform. It is the reform part of the triptych that Tokyo has struggled with too.

Exhibit B was the dismantling by Hollande of his government, particularly the removal of Arnaud Montebourg, an outspoken critic of austerity and its German supporters, as economy minister. That was presumably intended to send a message that the president is serious about economic reform, despite the rock-bottom popularity rating that it has helped deliver him. However, the shake-up also raises the risk that the ousted rebels could have enough allies in parliament to deprive the government of the majority it needs to implement reforms.

The next round of EU appointments will be revealing. Spanish Finance Minister Luis de Guindos is tipped to chair the Eurogroup of euro zone finance ministers. Should France secure the economics commissioner post for its former finance minister, Pierre Moscovici, then some sort of shift will have been enshrined.

As ever, Germany’s voice will be decisive and there too there has been more talk about “pro-growth policies” and an emphasis on economic reform over cutting debt.
Merkel has things to ponder at home, not just anaemic growth. Her conservatives were set to keep power in the east German state of Saxony after winning an election on Sunday but a new rival on the right, the anti-euro Alternative for Germany, secured its first seats in a state assembly.

Doing well in May’s EU elections is one thing but the anti-EU parties – AfD, UKIP et al – will wield much more influence if they break through at a national level.
Iraqi security forces backed by Shi’ite militias broke a two-month siege of the northern town of Amerli by Islamic State militants, helped by more U.S. air strikes. That marks the first significant military win for the band of Shi’ite security forces and militia that have now come together to fight IS.

One Kurdish fighter on a base north of Amerli described the American role as critical in ending the siege. Breaking with a post-World War Two policy of not sending arms to conflict zones, Germany has decided to send enough weapons to arm 4,000 Kurdish fighters in northern Iraq battling Islamic State insurgents. Merkel will talk to the Bundestag about the decision later today.

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