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The Beast From the East

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A chilly wind is blowing from the east and it has nothing to do with the weather. Russia tweeted that it is “not afraid of the cold” which is just as well with UK/Russian relations beginning to ice over.
 
On Sunday, one of the UK’s and indeed the West’s ‘biggest fans’ secured a fourth term with a reported 76.66% of the vote. Turnout, according to the Central Election Commission, was 67.47% and apparently, dear Vlad thanked Theresa May for boosting his support at the polls. I am somewhat dubious about the turnout but cannot deny that Putin is, in the hearts and minds of ordinary Russians, restoring their sense of pride in Mother Russia. He continues to prove that he can challenge the West time and again and get away with it, seemingly winning the ‘soft power’ contest as a result. His annexure of Crimea seems like a distant memory now, and the rebel presence in the Donbass region of the Ukraine, backed by Russian military support, continues unabated. Sanctions have not worked and it will be interesting to see the effect the current proposals will have following the nerve gas poisoning. At least the UK appears to have the verbal support of its most important NATO allies, but just what additional actions can and will be taken remains to be seen. Expect a lot of verbiage.
 
The Russian economy has undoubtedly taken a hit since 2014, in part due to Crimean based sanctions, but also as a result of the oil price war led by Saudi Arabia, in its attempt to break the growth of US Shale Oil. Russia has been working with OPEC to return the oil market to balance, by limiting the volume of oil produced by OPEC and Russia. Russia is currently the largest oil producer at c.10.8 million barrels per day, but is about to be eclipsed by the USA, with shale oil production rising to 6.95 million barrels per day, bringing total US production close to 11 million barrels per day and rising. This cut in oil production by Russia, together with the Crimean sanctions, has impacted Russian GDP, which achieved a record high in 2013 and subsequently fell by 38% by December 2016. In spite of this, Russia remains the eleventh largest economy and is set to move up the rankings to sixth place by 2022. The UK currently sits in fifth place and is expected to fall to ninth place by 2022.
 
As part of his drive to restore Russian influence and pride, Putin has embarked on a massive increase in military spending since 2014, putting Russia in third place behind the USA and China, spending 5.3% of GDP (c. $69.2bn for 2016). This compares with a continually declining UK military spend of just 1.9% of GDP (c. $48.3bn for 2016), leaving the UK in seventh place and short of its NATO commitment of 2% of GDP. France are in sixth place at 2.3% of GDP and Germany a lowly 1.2% and in ninth place.
 
The USA is rightly angry with its NATO partners and Trump has made a number of threats to his allies, citing the unfairness of leaving the USA to shoulder the military spend burden (3.3% of GDP). The world, rather than moving to a more stable and peaceful outlook, is looking increasingly more polarised and the UK needs to up its military spending and presence. This would help support its stated global aspirations post Brexit, not to mention retaining a significant defensive domestic capability.
 
Russia is also well placed within the strategic energy mix of Europe, with many EU member states heavily reliant on Russian gas supply. Germany and Italy are the most reliant, although Germany has been ramping up its renewable energy program. Whilst energy security is arguably compromised with such a heavy reliance on Russia, it is a two way street. Russia hopes to diversify more of its exports to Asia, but these attempts have as yet met with limited success, meaning Russia remains reliant on the EU for a large portion of its exports.
 
The current escalation of tensions with Russia poses many challenges to the UK and Europe. As such, no matter what the outcome of Brexit, the EU and the UK will have to maintain close cooperation from a security perspective.
 
On the data front for the week ahead, there are a number of key meetings and releases including the rates decisions of the BoE and the FOMC. Regarding the latter, market expectations have shifted from a gradual normalisation to an aggressive pace of hiking arising from fears that inflation will spike above the Fed’s target range. The dot plots for the December meeting were indicating three hikes, and a change to four hikes for 2018 with two more for 2019 would tip the scales from gradual to aggressive, pushing both yields and the dollar up.
 
The BoE warned in February that it would raise interest rates faster than markets were expecting if the inflation outlook evolves in line with its latest forecast. It is unlikely that we will see any actual change to the Bank Rate on Thursday, but a more hawkish rhetoric could have positive implications for Sterling.

 

All views expressed here are the Author’s own and are based on information available at the time of writing

 

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