UPDATE 2-Turkish lira slips but bond curve normalises
* AK Party wants more say over appointment of judges and prosecutors
* Suggests political turmoil to continue before elections
* Finance minister comments may have steepened bond curve
* Equities again underperform emerging market index (Updates for closing prices)
By Dasha Afanasieva
ISTANBUL, Jan 8 (Reuters) - Turkey's lira slipped against the dollar on Wednesday as the government bond yield curve, which had briefly inverted on speculation about an emergency rate hike to rescue the currency, returned to a positive slope.
The lira has hit several record lows since Dec. 17, when a wide-ranging graft probe began with a series of dawn raids and arrests that have led to the resignation of three ministers and the reported dismissal of hundreds of police officers.
In its latest salvo against the damaging corruption inquiry, the ruling AK Party sent plans to parliament late on Tuesday seeking more say over the appointment of judges and prosecutors.
"This is the latest sign that things are not about to calm down ahead of March local elections," Commerzbank said in a research note.
Ratings agency Fitch warned on Tuesday that "strains on institutional integrity" caused by tensions between the government and judiciary were among factors that could eventually weaken Turkey's creditworthiness.
However, Moody's, which raised Turkey's sovereign credit rating to investment grade last May, said in comments emailed to Reuters on Wednesday that domestic political risk was already embedded in its rating for the country.
The lira slipped slightly to 2.1776 by 1540 GMT from 2.1605 late on Tuesday, though it was firmer than Monday's record low of 2.1950.
The yield on Turkey's 10-year benchmark bond rose to 10.18 percent from 10.12 percent late on Tuesday, while that on the two-year bond fell back to 10 percent.
Turkey's yield curve is still much flatter than normal levels of around 50-100 basis points, but has steepened from an intra-day level of minus 7 bps hit on Tuesday.
An inverted yield curve is often a sign of credit stress, although the bond curve in Turkey has sometimes inverted before monetary tightening announcements.
Public comments by Finance Minister Mehmet Simsek on Tuesday may have partially reduced speculation about a monetary tightening as soon as the Jan. 21 policy committee meeting.
Simsek indicated that he expected the low-rate monetary policy to continue, saying Turkey was taking measures to keep domestic demand at reasonable levels without resorting to interest rate hikes - implying that he still had an understanding with the central bank on low rates.
The main Istanbul stock index closed down 1.85 percent at 67,331.70 points, underperforming the main emerging market index, which rose 0.23 percent.
"As further social and political unrest seems possible ahead of the two major elections this year, we see a noteworthy threat on economic stability that poses downward risk on the growth outlook in 2014," Deniz Cicek, economist at Turkey-based Finansbank, wrote in a note. (Editing by Andrew Torchia and Catherine Evans)