The UK is guilty of sleepwalking into the crisis in Ukraine and has not been as active or visible as it should be, according to a damning report into the British and European approach to the crisis by the main House of Lords committee on foreign affairs.

The report – the fullest evaluation of the Ukraine crisis to emerge from the British parliament – also finds that expertise within the Foreign Office towards Russia has diminished significantly, and according to the committee chairman, Lord Tugendhat, “led to a catastrophic misreading of the mood in the run-up to the crisis”.

The committee also warns that as a signatory to the 1994 Budapest memorandum, setting out the protection Europe would give Ukraine, “the UK had a particular responsibility towards the country and it has not been as active or as visible as it could have been”.

The warning comes just a day after RAF Typhoon fighters were scrambled to escort two Russian Bear bombers off the coast of Cornwall, and as a diplomatic row broke out after Michael Fallon, the defence secretary, issued a warning over Moscow’s threat to Nato’s Baltic states.

It comes amid heightened tensions between the UK and Russia over Vladimir Putin’s backing of separatist rebels in Ukraine.

Fallon warned that Putin could repeat the tactics used to destabilise Ukraine in Baltic members of the Nato alliance, saying that Nato must be ready for Russian aggression in “whatever form it takes”.

The judgment from the Lords will fuel the impression that David Cameron, partly due to the distraction of a long election campaign and partly to his stance towards the EU, has ceded foreign policy influence to Germany and France. He has been seen as a bystander as the latest phase of the Ukraine crisis unfolded in recent days.

The report is also highly critical of the EU, and the way in which competing national interests made an overarching policy hard to achieve.

The committee says if Russia does not change tack, sanctions need to be increased by following the US practice of targeting those close to Putin as opposed to middle-ranking officials in Crimea. The EU should also consider extending sanctions into the Russian financial sector, and the UK should stage an international donor conference in London.

The committee is chaired by Tugendhat, the former EU commissioner, and includes the former Conservative chancellor Lord Lamont.

The peers find: “The EU’s relationship with Russia has for too long been based on the optimistic premise that Russia has been on a trajectory towards becoming a democratic ‘European’ country. This has not been the case. Member states have been slow to reappraise the relationship and to adapt to the realities of the Russia we have today.”

Sir Tony Brenton, a former ambassador to Russia, told the committee that UK diplomacy was “pretty good”, but had suffered because of a loss of language skills, particularly in the Foreign Office.

This had had a direct effect on the capacity of the FCO to respond to recent events. There was “quite lot of complaint in Whitehall after the annexation of Crimea that the Foreign Office had not been able to give the sort of advice that was needed at the time”.

Within the Foreign Office, the committee suggests there has been a shrinking of the ability to think strategically, as well as a loss of deep political and cultural knowledge. Discussing the wisdom of further EU expansion to the east, the lords urge greater realism. They also suggest that although Putin was using the rights of the Russian minority in Lithuania and Latvia as a pretext to cause trouble, the rights of Russian minorities needed protection.

Sir Andrew Wood, the former British ambassador to Moscow, said on Friday morning he agreed with the committee’s conclusions. “It was a Europe-wide misreading and it was an American misreading as well,” he told the BBC. “There was a general assumption - as the report says - that Russia would get more and more democratic.”

He appeared to agree with Fallon’s comments that the Baltic states were under threat from Russia, saying: “It’s a dangerous moment because Russia is a state, in a sense, of frozen anarchy. It’s not a proper state. What they’ve done in Ukraine is begin an adventure and they don’t know how to end it, so there is some danger that their frustrations will over spill into other areas and the Baltic states have been under pressure from Russia.”

He added: “the majority of Russian speaking citizens of those Baltic states actually do not want change – they are not emigrating to Russia.”

Additional reporting by Frances Perraudin