By Marc Jones
LONDON (Reuters) - Tension in Ukraine and Russia curbed risk appetite on Thursday, weighing on world stocks and pushing the euro, already under pressure from talk of interest rate cuts, to a two-week low.
Sabre-rattling over Ukraine grew, with Russia's Defence Ministry quoted as saying fighter jets along its western borders have been put on alert, a day after it called a snap military exercise of 150,000 troops.
Ukraine said it would regard any movements by the Russian military in Crimea outside the Russian Black Sea fleet's base in Sevastopol as an act of aggression.
The Russian rouble slid to a fresh five-year low against the dollar, while Ukraine's hryvnia reached a record low after its central bank abandoned its managed exchange rate policy.
Wall Street was set for a subdued start, but the sharpening rhetoric in Ukraine held down Europe's main markets (.FTEU3). German stocks on the DAX (.GDAXI) suffered their biggest drop in a month and the euro dropped to a two-week low of $1.3641.
"The weakness in Europe today appears to be down to geopolitical uncertainty and the associated rise in risk aversion," said Robert Parkes, an equities strategist at HSBC in London.
There was plenty of additional pressure for the euro. A downward revision to Spanish fourth-quarter GDP figures came alongside ECB data showing little improvement in the amount of credit reaching euro zone firms.
German inflation figures also suggested there would be scant pick-up in the euro zone inflation when it is published on Friday.
The ECB meets next week and is under pressure to cut interest rates again and dip back into its unconventional policy cupboard to ensure the euro zone doesn't become mired in deflation.
FED IN FOCUS, YUAN STEADIES
The backdrop of geopolitical uncertainty saw investors head for the safety of the dollar (.DXY) and U.S. Treasuries, which both moved to two-week highs. The Japanese yen and Swiss Franc also gained.
In bond markets, the possibility more moves are coming from the ECB and a strong debt auction in Italy helped lower-rated Italian and Spanish debt keep pace with safe-haven German Bunds.
Futures prices pointed to another subdued start for Wall Street, which failed to build on record highs on Wednesday.(.N)
Markets were also cautious ahead of testimony from Federal Reserve Chair Janet Yellen, who is bound to face questions on recent soft U.S. economic news and what it might mean for policy.
If the view is that the recent icy weather is to blame, investors are likely to expect the Fed to keep trimming its bond-buying programme by $10 billion at each policy meeting and end it completely by the end of the year.
"Given U.S. debt yields fell and that U.S. shares were steady to softer, the dollar's strength should be regarded as a reflection of risk aversion rather than rising confidence in the U.S. economy," said Masafumi Yamamoto, chief strategist at Praevidentia Strategy.
Among commodities, copper dropped to a three-month low below $7,000 a tonne, extending its losses over the past week on recent concerns about slower growth in China.
U.S. oil and gold both steadied. Bullion had hit a four-month high on Wednesday but the stronger dollar left it at $1,332.30 an ounce, off Wednesday's high of $1,345.35.
After its recent falls, the yuan also saw a second day of relative calm, standing at 6.1279 per dollar, just off Wednesday's low of 6.1351. A bounce in Chinese shares also helped Asian shares <.MIAPJ0000PUS> eke out small gains.
Dealers suspect the People's Bank of China has engineered the recent decline in its currency to inject more two-way volatility into the market and wrong-foot speculators who had bet on its continued rise.
"It's possible that the Chinese authorities think they need a weaker yuan now to bolster the economy," said Hirokazu Yuihama, senior strategist at Daiwa Securities.
(Additional reporting by Hideyuki Sano in Tokyo; Editing by Larry King)