The crisis in Ukraine has been more severe than many of us had anticipated – and uncertainty remains high. As predicted, the UK, Europe, and the US have used financial sanctions as the primary tool to push back against Russian aggression. These include:

• Sanctions such as asset freezes and (in some cases) travel bans against President Vladimir Putin, Foreign Affairs Minister Sergey Lavrov, and more than 100 individuals close to the Russian government.
• Expanding the list of sanctioned financial institutions to large state-owned banks.
• Restrictions on the ability to do business with Russia’s ministry of finance, state-owned investment funds, and the Russian central bank.
• Additional restrictions on Russian (mostly state owned) enterprises’ ability to access financing in US dollars, euros, or sterling.
• Preventing Russian banks from accessing the SWIFT financial messaging system

We think the recent events introduce a different set of factors that have been largely off businesses’ radars for a long time – notably, the return of geopolitical risk.

Just a few months ago, when the pandemic and its aftermath dominated the economic narrative, geopolitical risks were seen as marginal – something that spiked occasionally but would fade over time. Things now appear very different. That western countries were not capable of containing Russia raises the prospect of further destabilisation, especially over the long term. 

But in the near term, central banks – already so keen to keep a lid on inflation – could face greater challenges as sanctions on Russia start to bite in western countries.

While the situation is fluid, we see the crisis influencing global FX markets in a number of important ways, which could lead to a weakening of the euro against sterling and the US dollar.

The European Central Bank (ECB) may not be quick to raise interest rates in the face of an ongoing crisis and its relatively strong links with both Russia and Ukraine. Compared with Europe, the lower direct exposure of the UK and US to Ukrainian and Russian economies means both the Federal Reserve and the Bank of England may take a different approach from the ECB.

A (relatively) weaker labour market in the eurozone, compared with the US and the UK, also gives the ECB slightly more flexibility to maintain loose monetary policy. On the other hand, stronger labour markets in the UK and US keep pressure on the BoE and the Fed to raise interest rates.

The escalation of tensions occurred at a time when crude oil prices were already rising, as supplies struggled to keep pace with surging demand fuelled by the reopening of the global economy. The Organization of the Petroleum Exporting Countries (OPEC) has remained quite conservative in its supply increases, and global production has been slow to recoup pandemic-era declines.

Western countries have a few options to manage higher prices and disruption, although the supply/demand imbalance may persist. These options include:

Coordinated strategic petroleum reserve (SPR) release

The 31 member countries of the International Energy Agency (IEA) are releasing 60m barrels from their emergency reserves, equivalent to 2m barrels a day for 30 days. However, strategic reserve releases are one-off, stopgap supply fixes, and as such are unlikely to have as lasting an impact as a more permanent increase in production.

Putting pressure on OPEC to accelerate supply increases

We think the pressure from major energy consumers on OPEC to increase near-term oil supplies is likely to be strong. But OPEC may not respond quickly. The conflict in Ukraine hasn’t (yet) created a significant disruption in actual oil supplies; rising prices reflect the increased risk of future supply disruptions. Complicating matters further is OPEC’s open coordination on oil markets with Russia as part of the group formally called OPEC+. The politics of OPEC working with the west and coordinating with Russia may prove tricky.

Finalising the joint comprehensive plan of action (JCPOA), aka the Iran nuclear deal

In a sense, it’s unsurprising that the significant stress in global energy markets is linked to reports of renewed momentum in the JCPOA. A completed deal with Iran could bring as many as 2m barrels a day back into global oil markets over time. However, despite some optimism, fundamental disagreements between the US and Iran on some of the deal’s key terms leave us sceptical that an agreement will be made soon.