May 11, 2014 / 10:14 AM / 4 years ago

Ukraine casts shadow as investors take pulse of fragile economy

BRUSSELS (Reuters) - U.S. and euro zone data will help investors take the pulse of the global economy this week, but the crisis in Ukraine threatens to spoil any improvement.

The Wall St. sign is seen outside the door to the New York Stock Exchange in New York's financial district February 4, 2014. REUTERS/Brendan McDermid

Steady prices and good retail sales are expected to show the U.S. economy in a more flattering light this week, in encouraging news for the Federal Reserve as it pares back the stimulus that has buoyed financial markets for the last few years.

In the euro zone, where many investors are wondering if the European Central Bank will follow Washington’s example by turning on its money printing presses, a continued but modest improvement in output is expected.

But a referendum on independence in eastern Ukraine called by pro-Russian separatists has underscored the threat of civil war in the country, a conflict that could rock confidence and hit trade between Russia and the rest of Europe.

“An escalation of the Ukraine crisis might be the trigger which leads to a correction and can bring uncertainty back to the rest of the world,” said Carsten Brzeski, an economist with ING. “The return of uncertainty can really cost growth.”

The crisis is having a dramatic impact on the already fragile Russian economy, dashing hopes that 2014 would be a year of recovery and placing the country instead on track for recession as investors dash to withdraw money.

Although European Union sanctions have been so far largely symbolic, the threat of stiffer penalties from the United States or Europe against Russia’s banks or industry is scaring investors.

Diplomats have told Reuters that the first companies would be added to the list of targets to be sanctioned this week, freezing their assets in Europe and marking a toughening of stance against Russia. The European Union is Russia’s top trading partner.


The conflict threatens to upset Europe at a delicate moment.

The 18 countries in the euro zone are expected to announce this week that economic output has increased at the strongest rate in three years. Germany, the bloc’s industrial powerhouse, is also set to report growth.

The recovery is fragile, however, with unemployment at record highs, banks reluctant to lend and sluggish prices meaning that the real burden of debts on countries such as Greece or Portugal is set to remain heavy.

Although the United States does little trade with Russia, some analysts fear that its business with Europe could be hurt.

“There could be a knock-on impact from Ukraine on the U.S. through Europe,” said Laura Rosner, an economist with BNP Paribas in New York.

To compound problems, China, the engine of the global economy, is slowing.

On Tuesday, a tally of China’s factory output and retail sales may portray a stable picture, following a recent improvement in exports.

The government has meanwhile hastened construction of railways and affordable housing, while cutting taxes for small firms.

In Europe, the president of the ECB, Mario Draghi, has said the bank is ready to act in June if slow price inflation persists.

Investors are betting the ECB will cut the cost of borrowing. Some also await the launch of a program of quantitative easing (QE) or printing money to buy assets, such as bonds.

But while pumping central bank money is easy to start, it is harder to unwind.

The head of the U.S. Federal Reserve Janet Yellen recently said that shrinking its $4.5 trillion portfolio of assets to the pre-crisis size of $800 billion could take the best part of a decade.

Britain’s economy too has rebounded thanks in part to the injection of central bank cash as well as record low interest rates.

Bank of England Governor Mark Carney is due to present new economic forecasts on Wednesday when he will seek to explain why it is not in a rush to start unwinding stimulus for an economy which is growing strongly.

“With QE, it’s easy to get in but difficult to get out,” said Richard Koo of the Nomura Research Institute in Japan.

“The market has got addicted to QE. I hope people are going to realize more the cost of getting out of QE. It’s going to be very messy.”

Additional reporting by Jason Bush in Moscow, Kevin Yao in Beijing; writing By John O'Donnell; Editing by Toby Chopra

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