The dramatic escalation of Ukraine’s civil conflict and fears of Russian military intervention have sent financial tremors across Eastern Europe, turning the region into the new fulcrum of the emerging market crisis.

“This has suddenly gone from a domestic Ukrainian story into a geopolitical clash,” said Lars Christensen, from Danske Bank.

The Russian ruble has fallen to a record low against the euro, with contagion reaching Poland, Hungary and Romania in recent days. “The moves in Russia are very like the events during the war in Georgia in 2008. Markets are pricing in the risk of Russian intervention,” he said.

Any deployment of Russian troops to stiffen the Ukrainian governmment - even if invited by President Viktor Yanukovich - could spiral out of control, leading to an East-West stand-off not seen since the Cold War. It might even be seen as replay of Russian intervention in Hungary in 1956 to prevent the country slipping out of the Soviet sphere.

German foreign minister Frank-Walter Steinmeier called Ukraine a “powder keg” as the death toll rose to 70, while Poland’s premier Donald Tusk warned of civil war.

Russian foreign minister Sergei Lavrov called the demonstrators fascists bent on a 1930-style “Brown Revolution”. Moscow has accused the EU of instigating a coup d’etat by mob violence.

Regis Chatellier, from Societe Generale, said there is a “high risk” that Ukraine will be pushed into default on its €60bn sovereign debt, triggering a credit shock for Russian banks. Sberbank and VTB are both large holders of Ukrainian bonds. Global emerging market bond funds hold 3pc of their portfolio in Ukrainian debt. “The spillover effect of a Ukrainian default would be significant, but not systemic,” he said.

The decision by the Ukrainian nationalist stronghold of Lvov this week to declare “independence” from Kiev has upped the ante, creating a volatile climate in which the Ukrainian army may be forced to intervene to head off civil war.

“Ukraine is on the verge of splitting into two countries. We’re looking at events that we have not seen in Europe since the break-up of Yugoslavia,” said one City economist with links to Lvov. “When you have this level of hatred and mistrust, anything can happen.”

David Fuller's view

The seeds for these problems were sown during the Soviet era, when millions of Russians were encouraged to move into the industrialised Eastern sector of Ukraine.  This created resentment and a long-term dilemma for which there is no easy solution. 

Russia clearly has the regional power and may use it shortly after Vladimir Putin returns from the Sochi Olympics next week.  He supplies the oil and gas upon which Ukraine is currently dependent.  He can also provide more loans.  Most significantly, he has unrivalled military power at his disposal. 

The Ukrainian nationals, not the Russians living in Ukraine, would like to join the European Union, which can only offer free trade at this time.  The USA will side with the EU, verbally, but it is not about to become involved in Russia’s back yard. 

The irony is that Ukraine has considerable shale oil and gas resources, as I reported over a year ago.  However, it lacks the technical knowledge and finances which could actually make Ukraine energy independent within a few years.  No US or other Western drilling companies would become involved without government support and guarantees which will not be forthcoming.  Russia will not help because it wants a supplicant Ukraine, not an energy rival which could eventually lower regional energy prices.  Russia’s Gazprom also sends over half of its European energy exports via a pipeline running through Ukraine.  

Investors are used to global conflicts but this one is potentially more dangerous, not least for emerging Europe.  It could also lift Brent crude oil (weekly & daily) more than we have seen in the last three weeks.  That would suit Vladimir Putin.  It would also delay Europe’s economic recovery prospects.  At worst, above $120 for more than a brief period it could affect the global economy. 

Currently, that is an outside risk rather than a probability.  Energy prices have the potential to decline over the medium to longer term, mainly due to increased oil and gas production with the help of more fracking, plus improvements in solar technology.  However, we should not ignore the troubles in Ukraine because no comfortable solution to this conundrum is currently apparent.