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The FTSE 100 and other European indexes are all in the red this morning because of the Turkish lira, a currency which is normally getting little attention from traders who are not emerging market specialists but has now made it on the top of the list of potential threats to European banks.

The lira crisis explained

The Turkish lira has been in decline since the beginning of the year with pressure notching up in March because of a series of decisions by the country’s strongman president Tayyip Erdogan, most of which were politically motivated rather than being supportive of the domestic economy.

Having a dispute with the US president hasn’t helped. One point of friction between the two countries is that after the US brought in a new set of sanctions against Iran, Turkey’s neighbour, Erdogan said that he was not obliged to follow them. The other is an extradition dispute. Turkey wants the US to extradite a Turkish cleric who they blame for masterminding the uprising against Erdogan in 2016. As the US doesn’t want to hand him over, Turkey is refusing to release a US pastor accused of being involved in terrorist activity.

Although this dispute has been simmering in the background for a while now, on Friday, when the lira’s decline was at its worst, President Donald Trump delivered a punch in the stomach to Turkey by announcing that the US would raise the tariffs on imports of Turkish steel to 50%. The US is one of its largest overseas buyers of Turkish steel and the Turkish steel industry is one of the most substantial sectors in the country,

Monday morning, when the tariffs took effect the lira fell from 6.53 to 6.88 against the dollar.

Turkish central bank slows down decline in lira

For the moment, though, Turkey’s central bank has managed to stem the decline of the Turkish lira by cutting the lira and foreign currency reserve requirements of the Turkish banks and the lira is now trading off the record low of 7.24.

The respite, however, is likely to be only temporary because the decline has spread a sense of panic across Europe. Among European banks, Spain’s Banco Bilbao Vizcaya Argentaria has the highest level of exposure to loans in Turkey – just under 14% of its loan book. Next is Italy’s UniCredit Group, which has around 4% of its portfolio in Turkish borrowing while ING, BNP Paribas and HSBC all carry a smaller exposure.

On the surface of it, even if the Turkish lira continues to slide, it should have a relatively small effect on European banks but in a situation where trust in the financial sector has been eroded the panic caused by the lira will cause more damage than the decline itself.

“Turkey itself, although in a dire situation, is not too much of a problem. It is the fear of contagion and the exposure of some international banks to the region that is causing the nervousness. The euro is showing signs of weakness as a result, giving, on the face of it, some relief to the beleaguered pound,” according to analysts at CFD broker Phillip Capital.

Please note this article does not constitute investment advice. Investors are encouraged to do their own research beforehand or consult a professional advisor.

Vanya Dragomanovic

Vanya Dragomanovic

Vanya is an award-winning financial journalist who has worked in both television and newswires. She spent over 10 years at Dow Jones covering commodity markets, including metals, coffee, cocoa and oil. She also reported from the floor of the London Metals Exchange, and appeared on CNBC to discuss international metals markets. Since then she has written for several leading financial publications, including serving as commodities editor for FTSE Global Markets.

Vanya continues to cover international commodities markets globally, specialising in particular on metals and alternative energy. She is also the author of a book on CFD trading.

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