* Investors seek reforms, fear populism
* Lira initially weakened 2.5 percent
* Shares rise 1 percent (Updates lira, adds London swap rates, dollar bonds)
By Daren Butler and Behiye Selin Taner
ISTANBUL, April 1 (Reuters) - The Turkish lira firmed on Monday, clawing back early losses after President Tayyip Erdogan’s AK Party lost control of the capital Ankara in local elections and trailed in Istanbul, Turkey’s largest city, as the last votes were tallied.
At 1523 GMT, the lira stood at 5.45 against the U.S. dollar, firming from Friday’s close of 5.5550. It had weakened as far as 5.7001 in early trade.
The lira tumbled almost 30 percent against the dollar last year and Turkey's economy has tipped into recession. In an echo of the 2018 crisis, the currency has swung wildly tmsnrt.rs/2CEaO11 in the last six trading days as the government and central bank unleashed a series of stop-gap support measures.
In Istanbul, the mayoral candidate of the main opposition Republican People’s Party (CHP), Ekrem Imamoglu, and his AKP rival, ex-prime minister Binali Yildirim, both said Imamoglu was around 25,000 votes ahead. Both parties had earlier claimed victory.
In Ankara, the CHP mayoral candidate, Mansur Yavas, won a clear victory, according to Turkish broadcasters. The AKP has said there were problems with many votes in both cities, and it would appeal results in every Ankara district.
The results, if they stand, will mark the first time the AK Party and its Islamist predecessors have lost control of Turkey’s two largest cities in 25 years.
“The (lira) market is focusing on the positive that it could have been a worse result for AKP and Erdogan has also said he will respect free markets, which would be positive if it happens,” said UniCredit EM FX strategist Kiran Kowshik.
Istanbul’s BIST 100 stock index rose 0.91 percent.
In a speech early on Monday, Erdogan pledged to focus on Turkey’s economic troubles.
“The expectation is that emphasis will be given to needed structural reforms in a period of four years without elections,” said one banker, who declined to be identified.
“If there is a delay in this, it will increase pressures on markets,” he said, adding that the lira was likely to remain in a 5.50-5.70 band while the uncertainty persists.
In the week leading up to the elections, Turkish stocks, bonds and the currency sold off, prompting the government to direct banks to temporarily starve a key London market of lira liquidity, according to officials.
Turkey’s dollar-denominated sovereign bonds surged on Monday, their best day since last September, when they were reeling from the currency crisis.
The lira overnight swap rate in London meanwhile soared to 400 percent from around 200 percent — well off the 1,200 percent to which it rocketed last Wednesday as the lira came under renewed pressure in the run up the vote.
Investors were also weighing up a statement on Monday from rating agency Moody’s, which said the erosion of Turkey’s foreign currency reserves is a credit negative and that their use to prop up the lira poses renewed questions about the central bank’s independence.
The renewed slip in Turkey’s financial markets and uncertain policy reaction to recession raises a risk of further capital flight, Moody’s said, adding that the local poll results would help determine the future path of economic policy.
Both Erdogan and Finance Minister Berat Albayrak, the president’s son-in-law, have promised to implement reforms after the elections to address economic woes.
Every decision by the government will have an impact on the lira as investors look forward to a reform package to restore confidence in the currency after last week’s drastic measures, said Piotr Matys, emerging markets forex strategist at Rabobank.
“While all previous AKP electoral victories were perceived as a source of political stability, on this occasion investors could be reluctant to give the administration benefit of the doubt that the next four years will be dominated by efforts to rebalance the economy and address structural vulnerabilities,” Matys said.
Additional reporting by Ezgi Erkoyun, Sarah Dadouch and Ali Kucukgocmen in Istanbul, Karin Strohecker and Tom Arnold in London; Editing by Jonathan Spicer and Catherine Evans