Share prices in London closed at their lowest level in three months last night after fears of a military conflict between Russia and Ukraine sent shudders through European financial markets.
Warnings from Nato and from Poland's prime minister, Donald Tusk, that the Kremlin was massing troops on the border with Ukraine led to a nervous day's trading in which the euro hit a nine-month low against the dollar and investors sought out safe havens such as gold and German bonds. And news that Italy had surprisingly fallen back into recession in the second quarter, coupled with evidence that the faltering recovery in the eurozone was having a dampening impact on German industry, contributed to the downbeat mood, which brightened only when shares on Wall Street rose in early trading.
Gold rose by around 1.5% to more than $1,300 an ounce as Vladimir Putin's announcement of tit-for-tat sanctions were seen as evidence of a deteriorating relationship between the west and Russia.
"We are getting closer to a situation where we really have an escalation of the conflict . . . sanctions being stepped up, and things moving out of control," said Elwin de Groot at Rabobank.
After dropping by more than 1% in early trading, the FTSE later pared its losses to close 46.32 points lower at 6636.16 following Wall Street's bounceback on Tuesday. Shares in Italy fell by more than 2.5%, while leading stocks in Madrid were down by more than 1% amid investor concerns that a fresh weakening in growth resulting from the crisis in Ukraine could reignite the debt problems of the eurozone's more vulnerable economies.
The euro dropped to $1.331 against the dollar after Germany said political tensions were causing consumers to become more cautious. German industrial orders slid in June at the steepest rate since September 2011, and the economy ministry said political tensions had probably led to more consumer caution. Berlin said industrial orders were down 3.2% in June - the biggest fall in three years - and were 4.3% lower than a year earlier.
The weakness was caused by a drop of more than 10% in orders to other members of the eurozone rather than to Russia, which accounts for 3% of German exports.
"Those German factory order numbers were just horrible. It really does just feed into the narrative that Europe is slowing down," said CMC Markets' chief market analyst, Michael Hewson. "I think equities are likely to remain on the back foot until such time as we get some clarity on what's going to happen in Russia/Ukraine."
The yield on German 10-year bonds dropped to 1.1%, while yields for countries in southern Europe affected by the debt crisis rose in response to news that a 0.2% contraction in Italy's economy in the first quarter of 2014 had been followed by a 0.1% fall in the second quarter.
Italy has been by far the worst performing economy in the G7 since the global recession began and analysts fear that its descent into a third downturn will make it harder to reduce a national debt already running at 130% of national output.
Despite Tusk's warning that a military clash between Russia and the Ukraine is getting close, the European Central Bank is not expected to take action when it announces the results of a policy meeting later today. But any sign that the ECB is cutting its forecasts for growth and inflation in response to recent events will be seen as a hint that the bank may be forced into more drastic action to boost activity.
Liza Ermolenko at Capital Economics said Putin's decision to announce his own sanctions would have significant costs for Russia. "A retaliation by Russia is likely to result in greater isolation from the global economy," she said. "In the short term, the economy would fall into a deep recession, with output contracting by 2%-3%. This could be followed by a rebound in 2015 on the back of a fiscal stimulus. But beyond that, the economy is unlikely to do much more than stagnate."
Rise in price of gold as investors abandoned shares for safer havens in light of the ominous news from Ukraine