By Mike Bird and Jon Sindreu 

The Turkish lira plunged Friday on investor concerns about the country's financial health, a shock that set off sharp falls in other emerging-market currencies, hit the euro and European banks, and pushed the dollar to a one-year high.

The market turmoil intensified when President Recep Tayyip Erdogan took a confrontational stance and talked of "economic war." President Trump shortly afterward said in a tweet that tariffs on Turkish aluminum and steel would be doubled amid a deepening diplomatic spat between the North Atlantic Treaty Organization allies.

The lira was down almost 16% against the U.S. dollar on the day in European afternoon trading and 47% in the past 52 weeks -- the second-biggest decline for a Group of 20 currency over the past decade, after the Russian ruble's drop in 2014. The lira is down 23% this week alone.

Turkish sovereign bonds also sold off, with yields on 10-year debt trading at above 20%, compared with 19% Thursday and roughly 12% at the start of May.

"First you put sanctions on it and then, when the currency weakens you accuse them of currency manipulation and double tariffs on them," said Jan Dehn, head of research at emerging-market house Ashmore Group. "Erdogan has single-handedly inflicted harm to Turkey to the point of extreme vulnerability, but this is the straw that breaks the camel's back."

Among Turkey's problems, the U.S. recently sanctioned two Turkish ministers because the country is holding an American pastor for what Washington believes are politically motivated reasons.

Even though the Turkish currency recouped some of its earlier losses on Friday, it dropped again after Mr. Erdogan addressed a crowd of supporters, asking Turks to exchange "any dollars, any euros or gold" for the domestic currency in order to shore up the lira. "Hopefully we will overcome this disaster and we will also successfully overcome this economic war," he said.

"If they have their dollars, but we have our people, our righteousness, and our God," Mr. Erdogan had said a day earlier.

For money managers, this was a sign that the Turkish government is unlikely to announce the measures needed to assuage markets, such as allowing the central bank to raise interest rates sharply or asking for an International Monetary Fund bailout.

Investors have for months questioned Turkey's financial health and ability to repay its foreign debts, but had so far seen it as an internal problem.

"That seems to have changed," said Sean Callow, currency strategist at Westpac.

The Stoxx Europe 600 Index fell 1.1% Friday, with its banking subindex declining almost 3%. The euro dropped 0.5% against the dollar to its weakest level since July 2017.

Haven assets like the Japanese yen, as well as U.S. and German government bonds, gained amid the turmoil.

The WSJ Dollar Index, a measure of the greenback's strength against a range of trading partners' currencies, rose 0.5%. Some other emerging-market currencies also weakened Friday, with the South African rand and the Hungarian forint falling 2.5% and 1.7%, respectively. The Russian ruble fell 1.1% and hit a two-year low.

While fears of market contagion appeared contained, the sharp moves recalled for some investors previous episodes when trouble in countries such as China and Greece fed wider market anxiety. Emerging markets were already grappling with a stronger dollar and fears over U.S. sanctions hurting global trade.

European banking shares dropped after it emerged that the European Central Bank was examining their exposure to Turkey. Shares in Spain's BBVA SA fell 6.2%, France's BNP Paribas SA dropped 5.1% and Italy's UniCredit SpA slid 6.4%.

The ECB's banking watchdog is monitoring the situation in Turkey and is in contact with eurozone banks about their exposure to the country, but its concern isn't too high at this point, according to a person familiar with the matter.

Data from the Bank for International Settlements showed that banks in Spain, France and Italy had the highest exposure to the Turkish economy at the end of the first quarter, adding up to $81 billion, $35 billion and $18 billion, respectively.

The broader impact of a weaker Turkish economy is expected to be small. Carsten Hesse, economist at German bank Berenberg, said that even a 20% fall in eurozone exports to Turkey would only subtract only 0.1 percentage point from the bloc's growth.

Still, some fund managers are concerned that fears about Turkey will trigger outflows from other emerging-market countries and push the dollar even higher.

Global markets have in the past reacted to financial stress even in relatively small economies when other countries' banks and financiers are involved.

In 2008, the collapse of Icelandic banks left many investors around the world either holding near-worthless assets or with deposits frozen and inaccessible for years. During the eurozone's sovereign-debt crisis between 2010 and 2015, concerns over the financial frailty of Greece hit markets world-wide. A limited depreciation of China's currency in 2015 also sparked stock market selloffs.

Charlie Robertson, global chief economist at Renaissance Capital, said that despite Friday's commotion, the longer-term "contagion effect" would be limited.

Turkey's small presence in the widely tracked MSCI Emerging Markets index meant investors won't be forced to sell assets in other developing nations to raise cash or lock in profits, he said.

Investors are now monitoring what the Turkish government will do to stem the rout, but Finance Minister Berat Albayrak -- Mr. Erdogan's son-in-law -- plans for a "new economic model" disclosed Friday failed to calm concerns.

Turkey's external debt as a percentage of gross domestic product is above 50%, one of the highest among developing economies, and the ability of its foreign-reserve pot to meet those demands is one of the weakest, figures by the World Bank and the IMF show.

"They're going to need the IMF, and the sooner the better," said Paul McNamara, investment director for emerging market debt at GAM International Management.

James Glynn, Saumya Vaishampayan, David Gauthier-Villars and Tom Fairless contributed to this article.

Write to Mike Bird at Mike.Bird@wsj.com and Jon Sindreu at jon.sindreu@wsj.com

(END) Dow Jones Newswires

August 10, 2018 10:06 ET (14:06 GMT)