- Exposure of EU banks in Turkey
- Italy problem could be even bigger…
- Fitch adds to fear of no-deal Brexit
In early August, rising concern over a no-deal Brexit sent the Pound to a monthly - and near annual - low of 1.108 in mid-market rates against the Euro. Since then, GBPEUR recovered to 1.122, before easing back to around 1.117 at time of writing. The peak of 1.129 came in mid-July. In comparison, the Euro has fallen this month against other major pairings.
Exposure of EU banks in Turkey
The Turkish Lira has plunged more than 35% against the US Dollar after the United States doubled steel and aluminium tariffs in a bid to put pressure on Turkey to release an American pastor held on terrorism charges. In return, Turkey has doubled tariffs on some US imports. The White House later said the tariffs would remain even if the pastor was released, as they related to security concerns.
Given the level of exposure of some significant Spanish, French and Italian banks to Turkey, concerns have been raised in the European Central Bank’s (ECB) Single Supervisory Mechanism, set up to monitor activity of banks, the Financial Times
The ECB fears that Turkish borrowers could default on foreign currency loans, which constitute around 40% of the Turkish banking industry’s assets and, due to the depreciation of the Lira, are now considerably more expensive to service and to settle. There are also worries that depreciation in the Lira could erode the banks’ excess capital. The USDTRY exchange rate rose from 3.75 at the start of the year to 7.08 last week and back to a low of 5.68 in the last few days.
News that Qatar is promising to invest $15 billion in Turkey’s financial markets briefly steadied the Lira against the US Dollar but, despite a successful conference call with investors by finance minister, Berat Albayrak, who has, at this stage, ruled out capital controls. The TRY is likely to come under further pressure and may need to follow the Venezuelan central bank in devaluing the currency to stabilise the markets.
So far, given the vulnerabilities of Sterling, the worries have not played significantly on the value of the Euro against Sterling, but, if the crisis continues and European banks are affected, then the Euro is likely to continue to be vulnerable to further Turkish Lira weakness.
Italy problem could be even bigger than Turkey’s
Market commentators point to another problem, which would leave the Euro even more exposed against GBP and other major currencies – that of the state of Italy’s finances and its debt mountain.
The country’s new coalition government, led by Prime Minister Giuseppe Conte, is due to agree a budget sometime around October.
Italy has the second largest level of debt in the Eurozone, at more than € 2 trillion, or the equivalent of 131.8% of Gross Domestic Product at the end of 2017.
The government, made up of the League and the 5-Star Movement parties, previously promised to increase public spending and make tax cuts. However, there is a concern that this would add to the government’s enormous debt burden and create a major headache for European banking for the next few years, as they have much more exposure to Italy than Turkey.
According to a statement from the prime minister’s office, things have changed. Giuseppe Conte and top ministers now say they have agreed to preserve the stability of state finances and lower the public debt,
The budget, “twins the government’s economic goals with the stability of public finances, in particular the continuation of a downward path in the ratio of debt to GDP.”
But following the deadly bridge collapse in Genoa, Deputy Premier, Matteo Salvini, has questioned spending constraints that affect safety and argues investment should be increased.
He says, “If external constraints prevent us from spending to have safe roads and schools, then it really calls into question whether it makes sense to follow these rules. There can be no trade-off between fiscal rules and the safety of Italians.”
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Further fears of no-deal Brexit
Ratings agency Fitch has joined the clamour of concern that the UK may well end up with a chaotic no-deal Brexit.
The currency markets are also worrying about the uncertainty and, as a result, Sterling has suffered against the Euro and other major currencies.
The fear is that Britain will leave the European Union in March 2019 with no trade arrangement other than reverting to World Trade Organisation tariff schedules.
In a statement, Fitch, one of the ‘big three’ credit rating specialists, says a smooth transition is less likely. Fitch believes its “base case” - that the UK would leave the EU in March 2019 with a transition period until around December 2020 and a framework for a future Free-Trade Agreement - no longer ranks as significantly more likely than other possible outcomes. That’s market speak for them having no idea which way it will go.
They went on to write that, “An intensification of political divisions within the UK and slow progress in negotiations with the EU means there is such a wide range of potential Brexit outcomes that no individual scenario has a high probability, Fitch Ratings says. We no longer believe it is appropriate to identify a specific base case. An acrimonious and disruptive "no deal" Brexit is a material and growing possibility.”
The time available to finalise a withdrawal agreement is getting shorter, while the UK and EU remain wide apart, it points out.
Even UK Foreign Minister, Jeremy Hunt, has admitted the risk of a no deal Brexit is increasing as the weeks go by. “Everyone needs to prepare for the possibility of a chaotic no-deal Brexit,” he said.
He says the European Union should change its attitude to prevent an outcome, which would not only hit the UK hard, but Europe, too. In fact, European Commission officials fear it may suffer more in the short term than Britain.
European Parliamentary elections are set to take place just weeks after Brexit and as countries have the right to veto major decisions, it is difficult for the EU to make quick decisions.
Jeremy Hunt says, “I think the risk of a no deal Brexit has been increasing recently, but it’s not what anyone wants and I hope very much that we’ll find a way to avoid that.” He adds, “We do need to see a change in approach by the European Commission.”
Scare stories abound of the effects of no-deal on the UK, from 12% being added to the typical weekly groceries bill and £1,000 a year being added to household bills overall; a scarcity of vital drugs and blood products to transport chaos, including planes being unable to fly. To be fair though, it is open season on speculation for everyone with any kind of vested interest.
Now, a new challenge is being mounted in London’s High Court by British Expats who say the recent ruling by the Electoral Commission of undeclared spending by the Vote Leave group, means Brexit is invalid.
The judicial review against the prime minister, Theresa May, has been submitted by the UK in EU Challenge group, which represents Britons living in France, Italy and Spain.
The government resists the action, saying it is out of time and that a similar challenge has previously been dismissed.
It’s no wonder that there are fresh jitters over GBPEUR – and we ought to expect more twists and turns until there is more certainty over the outcome and its implications for both Britain and Europe.
Guidance for buying Euros
Up until mid-July, the GBPEUR rate had a very formal pattern between 1.1270 and 1.15. That has changed and the previous support level around 1.13 is now capping this pair. So Euro buyers need to be thinking of target levels below there unless the Pound can shove its way above 1.13. If so, the previous range will re-establish itself for now. On the downside, the big risk is a fall below 1.10. If that happens, a much larger fall is likely, with 1.0760 being the most likely target. Risk management measures should therefore be placed below 1.10, but not much below.
Guidance for selling Euros
For Euro sellers, your risk is a break back above 1.13, which could create a drive to 1.15 or near to that level. If Sterling takes another hard knock, 1.10 is the obvious target for the interbank market, so set your sights just above there. A break of 1.10 opens a dive towards 1.0750. That would be nice but may not come to pass if the GBP buyers hold Sterling in check.