Istanbul: The sudden exit of Turkish Prime Minister Ahmet Davutoglu on Thursday frayed investors' nerves already tested by months of political uncertainty, with analysts warning of a period of sustained pressure for the lira and stock market.
Davutoglu's departure paves the way for the naming of a prime minister more pliant to the will of President Recep Tayyip Erdogan who has long sought to expand his influence on economic policy.
The lira lost almost 4 percent in value against the dollar on Wednesday -- its heaviest daily loss this year -- as news broke that crisis talks between Davutoglu and Erdogan had failed to resolve tensions between the two men.
After that hammering, the lira rallied slightly Thursday to trade at 2.90 to the dollar, a gain of 1.84 percent, but still still well off its 2.85 level against the dollar before the news broke.
"Politics has once again emerged as a major risk for the lira, which is likely to remain vulnerable in the coming days," analysts at Rabobank said in a note to clients.
Davutoglu said the ruling Justice and Development Party (AKP) will hold an extraordinary congress on May 22 where he will surrender his twin jobs of party chairman and prime minister.
The equity markets also took the news badly, with participants fearing the development was a move by Erdogan to tighten his grip on all areas of policy, including the economy.
After heavy losses in the last days as the risk of political uncertainty became clear, the Istanbul stock market's benchmark 100 Index rallied slightly to gain 0.39 percent to trade at 79,689 points.
Rabobank said Davutoglu had been perceived by markets as being "far more moderate" than Erdogan and the premier's exit "will be a major blow for the lira and Turkish assets," it added.
But even in his parting speech, Davutoglu sought to give a message of continuity and stability.
"No-one should make speculation about the economy and now one should play with the balance of the economy. Confidence and stability will continue," he said.
'Damage can be limited'
Erdogan's reputation as a safe pair of hands on the economy was harmed last year when he piled pressure on the nominally independent central bank to cut interest rates for the sake of growth at a time of high inflation.
Earlier this month, Turkey's respected central bank chief Erdem Basci stepped down after his mandate ended and was replaced by Murat Cetinkaya who immediately presided over a monetary policy meeting that resulted in a rate cut.
"The political uncertainty means that we're likely to see further falls in Turkish asset prices in the near term," said William Jackson, senior emerging markets economist at Capital Economics in London.
Investors' eyes now are likely to be on whether Erdogan is tempted to call snap elections -- which would be the third in just two years and would be a nasty jolt for the markets.
The president's key political goal is the creation of a presidential system which would require a bigger majority in parliament than the ruling party has now.
Another crucial factor will be the identity of the new prime minister and composition of the new cabinet, with investors keeping fingers crossed that markets-friendly Finance Minister Mehmet Simsek stays in his post.
However despite the drama of the situation, it appears that the AKP is determined to see a smooth transition, with Davutoglu staying on until the May 22 congress.
The lira rallied during Davutoglu's news conference as he made clear he had no intention of ever criticising Erdogan.
"The recent political developments are certainly negative for the outlook of Turkish equities, raising the risk profile," said Ozgur Altug, chief economist at BGC Partners in Istanbul.
"That said, the damage could be limited... if the replacement of PM is handled smoothly and swiftly," he added.
