The pound has fallen against the US dollar and could face additional pressure if tensions between Russia and Ukraine increase. The pound has risen against the euro, despite the fact that the British currency is sensitive to changes in risk sentiment. The euro has been more sensitive to the current political climate as Europe relies heavily on Russian gas.

Rising tensions between Russia and Ukraine

Following Russia’s move to send troops into eastern regions of Ukraine overnight with the purpose of “peace keeping”, the pound to euro exchange rate has risen. On Monday night, Russian president Vladimir Putin ordered his military to enter the Russian-controlled territories of Donetsk and Luhansk which he recognised as independent states.

The formal recognition signals an end to the seven-year peace deal known as the Minsk agreement and could give the Russian leader a pretext to invade Ukraine.

Western leaders condemned Putin’s move, with some announcing sanctions, and others holding emergency meetings. Boris Johnson is chairing a meeting of the UK’s emergency Cobra committee on Tuesday to sign off a package of sanctions against Russia.

Why is Russia interested in Donetsk and Luhansk?

The two self-proclaimed rebel republics of Donetsk and Luhansk escaped Kyiv’s control in 2014 and have been in armed conflict with Kyiv’s army since 2014. Their independence is not recognised by the international community. Kyiv and the West say Russia initiated the eastern uprising, by providing arms and placing troops across the border to reinforce them.

Moscow, on the other hand, claims that the Donbas region, a large part of eastern Ukraine, is Russian speaking and needs to be protected from Ukrainian nationalism. On Monday, during his 1-hour televised address, Putin said that “Ukraine has never had its own authentic statehood,” and sought to undermine the idea of Ukraine as an independent nation. Moscow also sees Ukraine as a buffer zone to NATO, which was founded in 1949 to protect against Soviet aggression.

Ukraine's Ambassador to the UK Vadym Prystaiko told BBC Newsnight: "I was listening to Putin for almost an hour, an historic debate with himself. And I have to tell you when a nuclear nation is calling your nation a historical mistake which has to be fixed, you have to be worried about what he has in mind."

How does this affect markets?

Given the nature of the situation and how fast things are changing, markets and the euro will remain  volatile in the near-term.

Investors will be interested in the scale of the sanctions, as severe sanctions could affect the supply of Russian gas and oil to the global economy. Europe which relies heavily on Russian gas would be exposed. Russia’s move against Ukraine has already increased the uncertainty around the economic outlook for the eurozone, according to the European Economic Commissioner Paolo Gentiloni.

Any further significant deterioration could weigh on the euro and help the pound rise against the single currency.  If Putin’s ambitions are controlled and he doesn’t wish to extent military action further, then the euro should recover.

 

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