Euro Recovers against Pound, Dollar as Investor Nerves Calm

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Euro exchange rates and stock markets recovered on Tuesday but volatile market conditions look set to remain in place amidst chronic uncertainty as to Russia's next moves in Ukraine.

The Euro and global stocks fell sharply following overnight news that Russia would recognise two contested territories in eastern Ukraine as sovereign states and would deploy its military in due course. The move was condemned by Western capitals who promptly promised sanctions.

But global stock markets soon overturned a deeply negative start to go sharply higher on Tuesday while the Ukraine-sensitive Euro flipped losses against the Dollar, Pound Sterling and a host of other currencies.

Strategist Andreas Steno Larsen says the market's reaction suggests there is a limited fear of contagion to Eastern Europe in general, "global risk assets of course dislike the current developments, but are likely to shrug it of unless a fullblown war breaks out."

Above: EUR/USD (top) and GBP/EUR (bottom).

Today focus should fall on how various Western capitals respond to the overnight decision of Russia to recognise separatist regions in Eastern Ukraine and President Vladimir Putin's assertion he did not recognise the integrity of the Ukrainian state.

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."

The UK, U.S. and EU announced sanctions over the course of the day but the extent of the measures proved limited as Western capitals look to maintain an arsenal in the event of an all-out war.

The UK announced five Russian banks and three high-net-worth Russian citizens would be sanctioned.

"Germany has also halted certification of the NordStream 2 gas pipeline. While details are still lacking, sanctions are unlikely to go as far, for instance, as blocking Russia’s use of the SWIFT payments system (this could hamper billions in loan repayments to European lenders). We also do not foresee aggressive Russian countermeasures, such as restrictions on gas exports to Europe," says Hans van Cleef, an economist at ABN AMRO.

The Euro was bid and stocks recovered, suggesting investors are increasingly sanguine about the outlook; perhaps suggestive of a view that Putin will resist taking further action now that he has effectively cut another chunk out of Ukraine.

The Pound to Euro exchange rate had been trading above 1.2020 amidst the market sell-off when news of Russia's actions broke, but was down by over half a percent on the day trading at 1.1950 amidst the recovery in risk sentiment.

The Euro-Dollar has recovered from lows at 1.1287 to trade at a high of 1.1366.

"The key question now is how far into Ukraine President Putin wants to go. Into the rebel-controlled areas of Donetsk and Luhansk, further to the broader Donetsk/Luhansk region, or even, beyond that?" says Kit Juckes, head of currency research at Société Générale.

"Clearly, pushing beyond the current area of conflict would escalate the situation as Russian troops engaged with Ukrainian forces, but beyond outrage, sanctions, and a likely humanitarian catastrophe, what implications would there be?" he queries.

According to Juckes the Euro's recent rebound might not last as higher energy prices will ultimately impact on Eurozone growth, more so than elsewhere.

"If this remains a regional issue (however bad it is at a human and diplomatic level) the most lasting market side-effect will be on energy prices. That's going to penalise growth in Europe relative to the US and is going to go on hurting energy-importers, including Japan. Within G10 currencies, I'm inclined to fade yen strength and remain euro-negative," says Juckes.

Above: German 40 stock index has been under pressure but has rallied in relief on February 22.

Brent crude oil rose 2.63% on Monday and a further 1.52% on Tuesday to reach $95.64 / barrel. Natural gas prices have however proven relatively resilient, hugging levels around $4.50 over the course of the past five trading days.

In the near-term the situation remains volatile and predicting Putin's next moves are near impossible.

"Should the Ukrainian crisis worsen further, the euro would correct again," says Asmara Jamaleh, Economist at Intesa Sanpaolo.

With regards to the Euro's medium-term prospects, Larsen notes that there now appears to be a weakening chance of a "hawkish shift from the ECB".

"Pricing of rate hikes from the ECB is soon back to the levels we saw before the Feb 3 press conference," says Larsen. "This makes A LOT of sense to me. Core EUR rates have more room to drop and the ECB is offered a decent chance to push back".

On February 03 the ECB surprised markets by dropping guidance that it would not raise interest rates in 2022, acknowledging surging inflation levels.

The Euro rallied in response.

It therefore stands that any easing of rate hike expectations amidst a push-back from the ECB could ultimately limit the Euro's recovery potential.