July 25, 2014 / 9:31 AM / 3 years ago

EMERGING MARKETS-Sanctions and escalation fears weigh on Russia

LONDON, July 25 (Reuters) - Russian shares opened lower on Friday, depressed by the threat of deeper economic sanctions in retaliation for Moscow’s role in Ukraine while broader emerging equities stayed just off 17-month highs hit earlier this week.

Moscow’s dollar-denominated RTS share index and its rouble-traded equivalent the MICEX were both around 1 percent lower as European Union governments mulled what steps they will take. The market is down 2 percent this week and looks set to extend last week’s near-8 percent loss.

However, the rouble held its ground, heading for a small weekly gain against the dollar, which analysts attributed to expectations sanctions will be limited in spite of recent escalations in Russia’s diplomatic standoff.

“I think the markets are seeing that the EU is looking at tougher measures and will move gradually but they also know that the Russian markets are resilient. We don’t expect there to be significant financial market disruptions such as default,” said Neil Shearing, chief emerging markets economist, at Capital Economics.

The rouble is supported by high interest rates and bond yields of around 9 percent and the central bank is expected to leave rates unchanged later on Friday as it grapples with above-target inflation.

On Thursday, ambassadors of the 28-nation EU discussed ways to limit Russian access to capital markets, arms and energy technology following the downing of a Malaysian airliner in an area of eastern Ukraine controlled by Moscow-backed separatists.

Earlier, the United States said Russia was firing artillery across its border, targeting Ukrainian military positions, and that Moscow intends to deliver heavy weapons to separatist forces.

The cost of insuring Russian sovereign debt against default rose, with five-year credit default swaps up 4 basis points from the previous day, to 212 bps, according to financial data provider Markit.

Ukrainian CDS moved up 9 bps to 796, a one-month high, as political uncertainty weighed following the resignation of the country’s prime minister who berated politicians for failing to pass legislation to take control over an increasingly precarious energy situation.

Ukraine’s 2017 sovereign dollar bond extended losses, falling almost half a cent to 101 after the previous day’s 2 cent fall in reaction to the government’s resignation

More broadly, the MSCI emerging stocks index was trading 0.2 percent lower but clinging close to 17-month highs as investors continued to bet on the U.S. Federal reserve persisting with loose monetary policy.

“Policy in the developed world is very loose and expectations remain for it to be loose. As it happens we think that the Fed will move slowly but ultimately rates will be higher than most of the markets currently expect and that remains a key risk for emerging markets,” Shearing said.

Data from EPFR Global showed in the week to July 23, emerging market-focused equity funds saw $78 million of outflows though bond funds received $260 million inflows.

Save for one week of outflow in June, emerging bond funds have enjoyed 20 weeks of inflow, banks said. Barclays analysts said this pattern suggested “a solid degree of confidence by investors bordering on complacency.”

In Turkey, the lira was lower against the dollar after the central bank governor raised the prospect on Thursday of cutting rates further.

Profit taking brought the main Istanbul share index off 13-month highs seen earlier in the week.

For GRAPHIC on emerging market FX performance 2014, see link.reuters.com/jus35t

For GRAPHIC on MSCI emerging index performance 2014, see link.reuters.com/weh36s

For GRAPHIC on MSCI emerging Europe performance 2014, see link.reuters.com/jun28s

For GRAPHIC on MSCI frontier index performance 2014, see link.reuters.com/zyh97s

For CENTRAL EUROPE market report, see

For TURKISH market report, see

For RUSSIAN market report, see ) (Additional reporting by Spriha Srivastava and Sujata Rao; Editing by Ruth Pitchford)

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