LONDON — The recent ratcheting up of tensions between Russia and Ukraine could spillover into the European economy, but may also present a buying opportunity, strategists have suggested.
The massive build-up of Russian troops and military hardware around the country’s border with Ukraine has drawn ire from NATO and the West, though Moscow has repeatedly denied any intent to invade its neighbor.
In a press conference with U.K. Prime Minister Boris Johnson on Tuesday, Ukrainian President Volodymyr Zelenskyy warned that any conflict would extend beyond the two countries and become a “full-scale war.”
In a research note Monday, Goldman Sachs chief European economist Sven Jari Stehn suggested an escalation could spill into the European economy in the form of lower trade with the region, tighter financial conditions and lower gas supply.
Goldman Sachs does not expect a significant impact on trade given that the euro area’s export exposure to Russia and Ukraine is relatively small. Stehn also noted that “while tighter financial conditions could, in principle, have notable effects on European growth, euro area financial conditions have not tightened meaningfully during past episodes of Russia-Ukraine tensions.”
“A reason for the limited financial spillovers is that the Euro area has weak cross-border banking exposure to Russia and Ukraine,” he added.
However, the Wall Street giant believes that spillovers via the gas market are the most important possibility to watch.
“While the effect of higher wholesale gas prices on consumers would likely be mitigated by limited wholesale-to-retail passthrough and government support schemes, we find that reduced gas supply could cause significant (although temporary) production disruptions across Europe,” Stehn said.
Russia is Europe’s largest gas provider, typically supplying 30-40% of the continent’s gas demand via its pipelines, but the euro area has recently begun shifting consumption away from Russian pipes toward liquified natural gas (LNG). Meanwhile, Russian gas flowing through Ukraine has reduced significantly in recent years, Goldman strategists highlighted.
“However, there is a potential risk that any escalation could result in sanctions on Russia’s Nord Stream 2 (NS2) pipeline, which would potentially end up curtailing flows to Europe for an indefinite period, exacerbating the tightness in European gas markets that our commodity strategists expect through 2025,” Stehn said.
“Taken together, our analysis therefore suggests that the growth risks from ongoing Russia-Ukraine tensions look manageable unless the tensions escalate and lead to sharply tighter financial conditions and/or energy supply cuts across Europe,” Stehn said.
The constructive medium-term outlook, barring any sudden escalations, was echoed last week by strategists at Oxford Economics, who said that the balance of probabilities implies a “buying opportunity” for affected regional and global assets.
However, they noted that there would be significant effects on asset prices and volatility in the near term if Russia was to make a further incursion beyond Crimea and its western border.
In this worst-case scenario, Oxford Economics believes the Russian ruble would weaken significantly, testing its 2015 high against the U.S. dollar of 83, while Russian stocks would also suffer.
“Euro zone equities would also see modest downside in this scenario as higher gas prices weigh on growth and squeeze profit margins. The Energy sector could provide relative shelter for investors wishing to hedge against this risk,” the strategists added.
However, in the base case scenario that the situation is resolved through diplomatic means, Oxford Economics expects markets to gradually calm down, Nord Stream 2 to get the green light, and asset prices to bounce back given Russia’s “strong fundamentals.”
In the event of a limited incursion, possibly in the form of air raids to destroy military infrastructure, the firm expects the U.S. to react with “biting” sanctions while the EU is consumed by internal divisions, and therefore deploys only mild sanctions such as a ban on electronic and semiconductor exports to Russia, or measures targeting Russian banks.
It would be this eventuality that sends the ruble to 83 against the dollar, at which point it could “easily be on a trajectory to 100, especially if there is a decisive breach,” the research note added.
In all three of these more moderate scenarios, the impact on stocks would likely be “relatively benign,” somewhat akin to the Crimean crisis in 2014, when Russian markets sold off in the short term, but a spillover to the euro zone was minimal and the bloc actually performed better than the global index for a six-month spell.