The European Union curbed Russia’s access to bank financing and advanced technology in its widest-ranging sanctions yet over President Vladimir Putin’s backing of the rebellion in eastern Ukraine.

EU governments agreed today in Brussels to bar state-owned banks from selling shares or bonds in Europe and restricted the export of equipment to modernize the oil industry, a key prop for Russia’s economy, two EU officials told reporters. New contracts to sell arms to Russia and the export of machinery, electronics and other civilian products with military uses will also be banned.

“The political implications of the escalation in tensions are likely to cast a further chill over relations between Russia and the West,” Citigroup Inc. analysts includingEric Lee and Tina Fordham said in a note to clients before the EU decision. “Economic costs are starting to bite, but it could be a while before the economic consequences bear domestic political costs for Russia.”

The U.S. is also preparing to announce tougher sanctions on Russia after months of separatist unrest in Ukraine’s easternmost Donetsk and Luhansk regions and the disaster involving a Malaysian Air jet¸ which U.S. officials have said was probably downed by a missile fired by the pro-Russian rebels. At least 10 soldiers and 28 civilians died in violence over the past 24 hours.

The new package of EU sanctions will “track pretty closely” with those already imposed by the U.S. and the Obama administration plans to unveil additional penalties as soon as today, PresidentBarack Obama’s spokesman said.

And:

For the first time, the EU sought to hobble broad swathes of Russian industry, with the goal of accelerating the flight of capital from the country. Russian economic growth will slow to 0.2 percent in 2014 from 1.3 percent last year, the International Monetary Fund said last week.

“Russia needs the opposite, Russia needs internationalization, globalization to make Russia a better place to do business,” Tim Ash, an emerging-market economist at Standard Bank Plc in London, told Bloomberg Television earlier today. “In the short term, the impact of sanctions could be to push Russia into recession.”

Taking aim at the Russian financial system, the EU prohibited state-owned banks from selling securities with more than 90 days maturity to European investors. The result will be “sharply increased costs of issuance,” the European Commission predicted in a background paper last week.

David Fuller's view

My impression is that these European Union sanctions are tougher than what would have been remotely possible before the MH17 massacre, or perhaps even last week.  Moreover, they will last for 12 months, albeit first reviewed at the end of October, but requiring unanimity from all 28 members to drop the sanctions prematurely.  That would appear unlikely.  The US has also responded in kind by increasing its sanctions to cover Russian banks. 

The interesting question is how will Putin react to these new sanctions?

The build-up to these sanctions really is all about Putin because he has dictatorial powers.  To protect himself, he is surrounded by ex-KGB kleptocrats, who are now known as members of the Federal Security Service (FSB).  Putin’s other cronies are oligarch billionaires who have fiefdom economic powers in Russia, granted by Putin, provided they never meddle in politics.  These are the big spenders in London and other fashionable European capital cities.  Having been targeted by sanctions, some of these oligarchs will understandably now feel less secure and happy under Putin’s iron rule.

My guess is that Putin will feel that he has to appear strong in response to these sanctions, to both maintain his apparent public popularity and also to keep the FSB and oligarchs in line.  There has been talk of reprisal sanctions against European fruit and also American exports of chicken products to Russia, although this would presumably not be popular unless Putin was able to replace them with similar imports from other countries.

Putin may try to seize more of Ukraine, although that would obviously not be without risk, in addition to being costly, in terms of lives and weaponry.  He may try to seek supplies from China, although that would be expensive while also increasing global tensions. 

In conclusion, tougher sanctions from the USA and EU, if enforced and maintained, could prove be a slow form of strangulation for Putin.  Meanwhile, the political and economic tensions are likely to worsen before they next improve.

Of course, this can be no more than conjecture on my part, so the situation could play out differently.  However, I will not be the only international investor to reach this conclusion.  Moreover, the market is a voting machine in the short to medium term.  If a sufficient number of other global investors conclude that they do no wish to carry more risk in Europe and the USA, especially when Asia is recovering, the Western markets could easily underperform until tensions with Russia subside and sanctions are removed. 

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