Pound / Euro Lower on Easing Russia-Ukraine Tensions, but Volatility to Stay Elevated

Above: Prime Minister Boris Johnson visits Nato and Poland. Picture by Andrew Parsons / No 10 Downing Street.

The Euro has rebounded against the British Pound and Dollar although uncertainty surrounding Russia's intentions towards Ukraine should ensure volatility in the single currency remains elevated near-term.

The Pound to Euro exchange rate fell back to the 1.19 handle, having been as high as 1.1950 on Tuesday, after it was confirmed some Russian army units were returning to base following the completion of exercises.

Investors read this as a signal of a potential easing of tensions.

"Reports of a partial withdrawal of Russian troops from the Ukraine border provided a market that was overly-stretched to the downside with an excuse to rally," says Chris Beauchamp, chief market analyst at IG. "Traders hit the buy button with a vengeance."

• Reference rates at publication:
  Pound to Euro: 1.1933 \ Pound to Dollar: 1.3555
• High street bank rates (indicative): 1.1700 \ 1.3250
• Payment specialist rates (indicative): 1.1873 \ 1.3462
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But there remain more than 130K Russian troops on standby on Russia's border with Ukraine, and a senior American source told the Mirror that the Kremlin will order an attack at 3am local time on Wednesday.

Prime Minister Boris Johnson said "intelligence that we are seeing today is still not encouraging", with Russian field hospitals being built close to Belarus' border with Ukraine.

That could only be "construed as preparation for an invasion", said Johnson.

In a potential pretext to invasion, Russian President Vladimir Putin said in an appearance alongside the German Chancellor following talks, "in our view what is now happening in Donbas is genocide."

Donbas is a region of south-eastern Ukraine, part of which is occupied by two unrecognised separatist states, the Donetsk People's Republic and the Luhansk People's Republic.

They are unofficially backed by Moscow in their attempts at separation from Ukraine.

Alongside the accusations of genocide on Ukrainian territory, Putin said what happens next in Ukraine is not entirely up to Russia.

"Intense cautiousness remains about Moscow’s agenda and investors remain highly sensitive to the geopolitical situation," says Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown. "Tensions are likely to remain high until there are more definite signals of de-escalation of the situation."

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A positive turn in market sentiment was triggered during London's Tuesday morning session when Russian newswire Interfax reported units of Russia's Western and Southern Military Districts were heading back to base by rail and by truck at the conclusion of a training exercise.

"Units of the Southern and Western Military Districts, which have accomplished their missions, are boarding trains and trucks and will head for their garrisons later today. Some units will join military convoys and will perform self-propelled marches," Russian Defense Ministry spokesman Igor Konashenkov told the newswire.

Declines in the Pound-Euro exchange rate suggest a reversion to pre-geopolitical panic levels which were decided by relative central bank policy expectations.

Pound Sterling ended 2021 and started 2022 on a strong footing as markets priced in higher interest rates at the Bank of England, but recently they have done the same for the Euro.

The Euro rose after the ECB's February 03 policy meeting at which the Governing Council signalled a 2022 rate hike would now be a consideration.

Euro exchange rates reclaimed ground lost to the Pound and Dollar amidst a rise in Eurozone yields but it remains to be seen how much more this repricing of ECB rate hikes can offer.

Indeed, although the initial market impulse was to buy Euros some analysts warn the ECB is still likely to deliver significantly less in terms of hikes than the Bank of England and Federal Reserve.

"The ECB pivot warrants an upgraded euro outlook, but a modest one rather than a sea change as it has come amid a broader synchronized central bank move," says Meera Chandan, a strategist at JP Morgan in London.

The market currently anticipates the Fed's base rate to be at 1.45% by year-end and the Bank of England's Bank Rate to be at 1.75%.

By contrast, the ECB's Deposit Rate is seen at -0.11%.

"Rather than getting carried away with the immediate EUR-positive impact of ECB hikes at the back-end of the forecast period, we are instead stressing that cash rate differentials will continue to move in the USD’s favour as the Fed delivers four hikes, maybe five, before the ECB gets going," says Chandan.

As such the Euro's upside might be limited to the relief rally that follows the easing of tensions on the Ukrainian border with Russia.