The City woke to grim news this morning. Russia’s renewed offensive in the Donbas region is not just a humanitarian catastrophe in the making; it is a stark reminder that geopolitical risk remains underpriced in financial markets. The UK government’s warning of ‘renewed aggression’ should send shivers down the spine of any investor who thought the worst was over.
Let’s talk about the bottom line. War is expensive. It inflates energy prices, disrupts supply chains and, most critically for my readers, it pushes central banks into a corner. The Bank of England is already wrestling with inflation that refuses to budge. A protracted conflict in eastern Ukraine means more upward pressure on grain and metal prices, squeezing households and corporate margins alike.
Gilt yields have been oscillating wildly this week. The 10-year yield briefly touched 4.5 per cent before settling back. That is not the behaviour of a market at ease. It is the tremor of a system digesting the reality that the fiscal headroom the Chancellor so carefully guarded is now at risk. Military aid and sanctions enforcement cost money. Money that must be borrowed or printed. Neither option is palatable.
Capital flight is the unspoken worry. The ruble has been surprisingly resilient thanks to capital controls, but that is a facade. Real money, the kind that moves markets, has been quietly rotating out of emerging Europe for months. If the Donbas offensive escalates into a wider mobilisation, expect that trickle to become a flood. Safe havens like gold and the Swiss franc will benefit. Sterling? Less so.
The UK’s warning is timely but late. We should have priced this in weeks ago. The market’s job is to anticipate, not react. Right now, it is reacting. The VIX, Wall Street’s fear gauge, is creeping higher. That is a sign that the complacency of the summer rally is fading.
For the retail investor, the advice is boring but true: diversify, reduce leverage, and hold some cash. For the Treasury, the advice is unwelcome but necessary: start planning for a prolonged fiscal strain. Wars do not end on balance sheets, but they certainly show up there.
In the end, this is about confidence. If the UK and its allies signal hesitation, the markets will punish that weakness. If they act decisively, the risk premium shrinks. The Donbas is not just a battlefield; it is a bellwether for global stability. And the bond market is watching closely.