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Gun attack threatens to derail Ukraine peace deal

A deadly gun attack in eastern Ukraine at the weekend threatens to derail a peace deal to prevent a broader conflict in the region and should keep geo-political risk high on the agenda for markets, analysts say.

At least three people were killed in a gunfight on Sunday near a Ukrainian city controlled by pro-Russian separatists, putting at risk a deal agreed in Geneva last week to end a crisis in Ukraine.

Read MoreUkraine accuses Russia of staging fatal attack

In an interview with NBC's 'Meet the Press' at the weekend, Ukraine's interim Prime Minister Arseniy Yatsenyuk made it clear what needed to be done to stabilize the situation.

"If Russia pulled back its security forces and former KGB agents, this would definitely calm down the situation," he said.

According to a report from Reuters, the pro-Russian separatists said armed men from Ukraine's Right Sector nationalist group had attacked them. The Right Sector denied involvement, saying Russian Special Forces were behind the clash.

In an agreement signed in Geneva last week, the European Union (EU), Russia, Ukraine and the U.S. agreed that illegal armed groups would go home in a process to be overseen by Europe's OSCE security watchdog.

Read MoreGeneva talks on Ukraine face steep hurdles

"This deal remains on the razor edge," analysts at Mizuho Corporate Bank said in a note on Monday. "Shootings in eastern Ukraine over the weekend show that the crisis is far from resolved."

They added: "Potential risk aversion remains in the background. Should this be the case, safe haven assets will be favored."

A pro-Russian activist stands guard outside of the Donetsk Regional Administration building on Easter Sunday April 20, 2014 in Donetsk, Ukraine.
Getty Images
A pro-Russian activist stands guard outside of the Donetsk Regional Administration building on Easter Sunday April 20, 2014 in Donetsk, Ukraine.

Tougher Russia sanctions?

A failure of the Geneva deal could bring tougher sanctions from the West against Russia, but analysts said they expected the crisis to remain contained.

"Something like this is always a risk-off pressure on markets, but it is fairly clear the West is going to hang Ukraine out to dry," Bank of Singapore Chief Economist Richard Jerram told CNBC.

"It is fairly clear we have no interest in putting any serious sanctions on Russia, so from that point of view it doesn't look like it will escalate more broadly," he added.

Read MoreRussia to Western business: Everything's just fine

The Ukraine crisis erupted late last year when former President Viktor Yanukovich rejected closer ties with Europe, sparking protests in the capital.

The protests turned violent earlier this year, prompting Yanukovich to flee the capital Kiev in February, with a pro-Western interim government taking control.

Not long after that Russia used its military to back separatists in Ukraine's Crimea, before Russian President Vladimir Putin signed a document annexing the peninsula. The U.S. and EU responded with sanctions on Russian officials in the biggest strain in relations between the West and Moscow since the Cold War.

What Ukraine needs

Yatsenyuk told 'Meet the Press' Ukraine needed economic and financial assistance from the West.

"We need a strong and solid state, we need financial and economic support. We need to overhaul the Ukraine military, modernize our security forces," the country's prime minister said in response to a question about whether Ukraine was strong enough to stop Russia in east Ukraine.

"We need to be in a strong shape to stop Russia and we need support from our western partners," Yatseniuk said.

The EU last week formally approved a one-billion euro assistance package to Ukraine. U.S. Vice President Joe Biden will meet with Ukraine's acting president, Oleksander Turchinov, and Prime Minister Yatsenyuk in Kiev on Tuesday.

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