Cliff Taylor: What is happening as the latest sanctions on Russia bite?

What is the reaction to the weekend step-up in economic sanctions?

Predictably financial markets are reacting sharply.

The main action is in Russia itself, where the rouble has collapsed in value, the stock market remained closed this morning and interest rates have more than doubled.

More widely, European share prices are down and oil and gas prices are back on the rise again – a reflection of fears about the economic impact of the conflict and particularly its impact on energy supplies from Russia to Europe.

Why has the rouble collapsed?

The Russian currency had already been under pressure due to fears about the impact of the war on the Russian economy.

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Its collapse on Monday – down by as much as 30 per cent plus against the US dollar, though little trading is happening – follows the stepping up in economic sanctions over the weekend.

The key measure was restricting the access of the Russian central bank to its reserves of foreign currency held in western countries.Analysts have been watching to see how this would operate and on Monday the US made a far-reaching order banning transactions with the Russian central bank.

The central bank would have used some of the $600 billion (€535 billion) in reserves to support the rouble on world markets – by selling foreign currency and buying the Russia currency. The reserves are vital to help Russia ride out sanctions and any hit to foreign earnings.

Now that its access to much of its reserves appears to be cut off, the rouble is collapsing. The central bank more than doubled interest rates to 20 per cent on Monday morning to try to make it more attractive to hold the currency, but even this is unlikely to offer much support.

Russia is also starting to introduce capital controls, to try to ban the movement of foreign currency out of the country. The central bank has ordered companies with foreign currency reserves to start selling them and to buy roubles to support the currency and foreign investors cannot sell assets.

And on Monday afternoon Russian president Vladimir Putin said that from tomorrow Russian residents would be banned from moving cash into foreign bank accounts.

How serious is this for Russia?

Very serious. It is being effectively shut off from much of the global financial system, with some of its key banks also not being allowed to use Swift, the system which allows money to be transferred internationally between banks.

This will further damage Russia’s ability to trade. Already there are queues at Russian banks on Monday morning as people try to access cash and particularly US dollars, fearing the rouble will devalue further.

Its financial system could quickly come under threat with confidence in its banks now very shaky. While there is little trading in Russian assets, the quoted value of Russian bank shares and government bonds on international market has fallen sharply amid talk of Russian defaulting on foreign debt repayments.

The currency’s collapse will deal a devastating blow to the buying power of Russian business and citizens by pushing up the price of imports dramatically and could spark hyperinflation on domestic markets.

Meanwhile Russian banks are already increased interest rates for borrowers. And there are increasing signs of investment flowing away from Russia, as the Norwegian sovereign wealth fund said it will ditch Russian assets and BP has said it will divest itself of its 20 per cent stake in Russian energy company Rosneft.

Meanwhile shipping company Maersk has said it is considering stopping all container bookings in and of Russia.

All this points towards a big longer-term hit on the Russian economy and its people – and the longer the crisis continues the worse it will get.

Why are European shares falling?

Because of fears of the wider economic impact. Some of this is driven by uncertainty – investors have no idea how the war in Ukraine will pan out or the longer-term implications for European politics and security.

In these situations riskier assets like shares are sold, investors put their money into safe havens like bonds, cash or gold and sit and wait to see what happens. Western central banks will be closely monitoring any signs of liquidity problems which could knock on from the freezing of Russia’s reserves and the wider financial sanctions.

Already there are reasons to fear an impact on the economic outlook – another reason for investors to sell shares. The most obvious reason is soaring energy prices, which imposes a cost on importing economies – and fears of supply disruption in gas and oil from Russia.

For now it appears that the Swift system is to remain operational for purchases of energy by Europe from Russia – the supply of gas is particularly sensitive here. And the US ban on transactions with the Russian central bank also appears to exclude energy.

In a fast-changing situation, this is a key area to watch.

For Russia, restricting gas flow to Europe would hurt the west, but would also rob of it vital foreign currency revenue.