Hungarian and Polish stocks fell sharply on Thursday, setting them on course for their biggest drops in almost two years, and central Europe's currencies sank after Russia invaded Ukraine. Trading was volatile, with stock markets opening to steep declines before regaining some ground, although indices were still well down on the day.

The BUX index in Budapest, which lost more than 11% in early trade, was down 9.0% at 1011 GMT. Hungarian bank OTP , with operations in both Ukraine and Russia, fell almost 14% to lead the losses.

The markets reacted to Russia's all-out invasion of Ukraine, the biggest attack by one state against another in Europe since World War Two. Central European countries, most of which border Ukraine, condemned Russia's attack. European Union officials said the bloc's leaders would impose new sanctions on Russia, freezing its assets, halting its banks' access to European financial markets and targeting "Kremlin interests."

'Stagflation' Fears

Analysts said the conflict raised "stagflation" risks for central Europe and the rest of the continent, as the impact can push up energy prices that have already been feeding an inflation surge and hit economic recoveries.

"I don't think sanctions will be so harmful to the CEE [Central and Eastern Europe] region as exports to Russia are rather limited, in many cases less that 1% of GDP," Juraj Kotian, head of CEE macro/fixed income research at Erste Group Bank, said. "If we see higher oil and gas prices, there is a question mark on how central banks will react, because the main inflation will be supply driven."

Central European rate setters have all been tightening policy to battle an inflation surge since last year. Czech central bank Governor Jiri Rusnok said on Wednesday the escalating crisis between Russia and Ukraine would have an inflationary impact through higher energy prices and a downward effect on growth. Currencies fell around 1% or more on Thursday. The Czech crown weakened beyond 25 to the euro for the first time since late-December, before returning to 24.863 per euro, down 1.0% on the day.

The Polish zloty was down 1.0% at 4.623 to the euro. The forint, after one of the region's sharpest falls in early trading, settled off daily lows at 365.10 to the euro, down 1.4%. Bond yields rose in the region, widening the spread with German bunds by as much as 22 basis points in Poland. Warsaw's blue-chip index lost 8.8%.

If the losses seen in Poland and Hungary hold, they would be the biggest daily drop since the outset of the coronavirus pandemic in early 2020. "Definitely there will be a risk-off mood for a couple of days as the market assesses (the situation)," Pavel Sobisek, a UniCredit economist in Prague, said.