UPDATE 2-Turkish lira weakens 2% after central bank governor sacked

The Turkish lira weakened 2% against the dollar on Monday after President Tayyip Erdogan dismissed the central bank governor, laying bare differences between them over the timing of interest rate cuts to revive the recession-hit economy.

At 0700 GMT, the lira stood at 5.7620 to the U.S. currency, having weakened as far as 5.8245 in early Asian trade as investors fretted about the implications of the move for central bank independence. The lira is down about 8% this year after having plummeted 30% last year during the currency crisis. The main share index fell 1.5%, with banks down 2.3%. Turkey's dollar-denominated bonds dropped across the curve.

Isik Securities analyst Yusuf Kavak said the bank was now expected to cut rates more sharply when it meets on July 25. "The expectation has taken hold in the market that there may be a stronger interest rate cut," he said.

The governor's dismissal comes just days before Turkey is expected to take delivery of Russian air defense systems, a development likely to trigger U.S. sanctions, which could put the lira under renewed pressure. "The S-400s are expected to be delivered this week. If U.S. sanctions come onto the agenda, along with the central bank expectation, the lira may move to the 6 (to the dollar) level and beyond," Kavak added.

Governor Murat Cetinkaya, whose four-year term was due to run until 2020, was replaced by his deputy Murat Uysal, a presidential decree published early on Saturday in the official gazette showed. Uysal, who has served as deputy governor for three years, is known as one of the more dovish of the bank's rate setters.

No official reason was given for the sacking, but government sources cited Erdogan's frustration that the bank had kept its benchmark interest rate at 24% since last September to support the lira. The newspaper Hurriyet on Sunday quoted Erdogan as telling a meeting with his party's lawmakers that he had dismissed Cetinkaya for rejecting the government's repeated demands to cut rates.

In a written statement on Saturday, Uysal said he would implement monetary policy instruments independently with a focus on achieving and maintaining the primary objective of price stability. "In his first remarks, Murat Uysal said the communication channels would be used at the highest level in line with the price and financial stability goals," the bank said, adding that Uysal would hold a news conference in the coming days.

Despite the new governor's assurances, critics say the move once again showed that Erdogan was determined to control monetary policy and that Turkey would witness a period of rapid rate cuts. Two government sources told Reuters that disagreement between the government and the governor over monetary policy had intensified in the past few months.

Cetinkaya raised the benchmark interest rate by a total of 11.25 percentage points last year to support the lira, pushing it to the current 24%. The Turkish economy shrank sharply for the second straight quarter in early 2019 as the crisis, persistent double-digit inflation and high-interest rates took a toll on overall output.