Germany's Baerbock says Germany to end Russian oil importsA day after France's Le MaireThis could push EUR, GBP lower says BMO CapitalGBP/USD could go as low as 1.20

Above: File image of Annalena Baerbock. Image sourced: AICGS, Flickr. Licensing: Creative Commons 2.0.

The EU is moving towards a future ban on Russian oil according to the bloc's two most senior finance ministers, an outcome which could provide sizeable downside risks to the Euro and British Pound says one analyst.

BMO Capital Markets has considered the outlook for the Euro, Pound and Dollar in the event that EU capitals agree on an oil ban and find only one winner under such a scenario: the Dollar.

The Euro would be an outright loser, but how the Pound to Euro exchange rate trades will be more nuanced says BMO Capital's European FX Strategist, Stephen Gallo.

"While we would expect the EUR to initially underperform the GBP in the event of a full German/EU embargo on imports of Russian fossil fuels (i.e. coal, lignite, oil, and natural gas), we don't think a materialization of this risk would be the catalyst for a move to 0.80 in EURGBP," says Gallo in a note out midweek.

EUR/GBP at 0.80 gives a Pound to Euro exchange rate of 1.25, which would represent Pound Sterling's strongest level since just before the Brexit referendum of 2016. (Set your FX rate alert here).

The economic shock of a ban on Russian oil by the EU is increasingly likely after German Foreign Minister Annalena Baerbock said Wednesday Germany was to end oil imports from Russia by End-2022.

Baerbock's comments followed those of German Finance Minister Christina Lindner who said Germany can end dependency on Russian coal and oil faster than gas.

He said a ban would recognise it is crucial to hurt Russian president Vladimir Putin's war chest "more than ourselves".

As a result, Germany was standing ready for further sanctions on Russia.

Lindner's comments follow on from those of French Finance Minister Bruno Le Maire who said on Tuesday that an embargo on Russian oil at a European Union level was in the works, adding that France's President Emmanuel Macron wants such a move.

"I hope that in the weeks to come we will convince our European partners to stop importing Russian oil," Le Maire told Europe 1 radio.

"An EU Russian oil embargo is really in the works: allegedly, this is set to be announced immediately after the results of the French election on Sunday – providing Macron wins, of course," says Michael Every, a global macro strategist at Rabobank.

BMO's Gallo says should a full embargo be enacted, 2022 will flip from being a difficult year to a brutal one for the Euro Area (particularly H2), and the risk of a technical recession in Germany by the end of H1 2023 will increase measurably.

The Euro would therefore likely remain under pressure in the event of a Russian oil ban.

The UK said it would ban Russian oil from year-end and the EU would almost certainly set a future date for any outright ban, blunting any initial market shock.

BMO Capital says the UK economy is also highly price vulnerable to a full EU embargo and this should weigh on the Pound.

"On balance, the scramble for supply caused by an embargo would probably lead to a more severe squeeze on the cost of living and put the BoE in a bind," says Gallo.

It is expected Europe would bear the crux of the economic hit of an oil ban and the Dollar would benefit against the single currency and other regional currencies.

"Provided these risks remain in Europe we would continue to fade rallies in GBPUSD above 1.30, and we think an embargo on Russian fossil fuel imports by Germany and the EU would be a catalyst to push the pair comfortably below that figure," says Gallo.

At present BMO Capital thinks the one-month probability of this risk materialising is around 30%, but note this risk is rising.

Regarding Euro-Pound price action in the event of an embargo, "we would look for a re-test of the 0.82 level on a kneejerk response to a full embargo as an opportunity to sell GBP," says Gallo.

(EUR/GBP 0.82 = 1.22 GBP/EUR).

Explaining the limited upside in Sterling, Gallo says: "In the event of a full embargo, neither the EU nor the UK are likely to escape a period of 'stagflation'. It's possible that stagflation in the Euro Area will be more acute than in the UK, but we think predicting this outcome is effectively a 'coin toss'".

He looks to sell EUR/GBP on forays above 0.84 and 0.85, (GBP/EUR dips below 1.19 and 1.1760).