* Turkish lira drops 2.4 percent against dollar
* Shares down 3.6 percent, bond yields jump
* Turkey-US spat hits visa services in both countries
* Central bank says watching developments closely (Adds central bank comments, analyst comment, bonds)
By Daren Butler and Can Sezer
ISTANBUL, Oct 9 (Reuters) - Turkey’s lira, stocks and bonds all tumbled on Monday as the United States and Turkey cut back visa services, signalling a sharp deterioration in relations between the NATO allies, and the central bank said it was following developments closely.
Deputy governor Murat Uysal told Reuters the bank did not see forex liquidity problems, while Turkey’s main business group warned economic relations would suffer from the disagreements.
“The step taken by the United States has had a psychological impact and led to the pricing of political risk in a real sense,” said Is Invest equity research manager Bulent Sengonul.
The lira dropped 2.4 percent and stood at 3.7030 against the dollar, retreating from 3.6160 at Friday’s close. It was quoted as having touched a level of 3.9223 overnight.
The main BIST 100 stock index fell as much as 4.7 percent and was down 3.6 percent at 100,400 points at 0840 GMT.
Last week, a U.S. consulate employee was arrested in Turkey on charges of links to U.S.-based Muslim cleric Fethullah Gulen, blamed by Ankara for last year’s failed military coup. Washington condemned the arrest as baseless.
The U.S. mission in Turkey then suspended all non-immigrant visa services at U.S. diplomatic facilities in the country. The Turkish embassy in Washington followed suit.
The dispute with the United States coincides with deep strains in Turkey’s relations with another key ally Germany and with Turkish military activity at the Syrian and Iraqi borders, though the market impact of these has so far been limited.
“This looks like a really serious situation,” said Blue Bay Asset Management strategist Timothy Ash.
“The (Turkish central bank) CBRT will need to move very quickly to calm market sentiment. If the lira continues to see selling pressure, the CBRT will have to move quickly to hike policy rates in defence of the lira,” he said.
However there could be political pressure against such a move, given President Tayyip Erdogan’s dislike of high interest rates.
Erdogan had been expected to hold a news conference on Monday morning before departing on an official visit to Ukraine, but did not do so. He was set to speak in Kiev later in the day.
Deputy central bank governor Uysal said banks’ foreign exchange accounts were at their highest levels in recent times, and that the lira was already weak and at a competitive level in real effective exchange terms.
He also said some investors who favoured lira positions in swap markets were readjusting them over geopolitical concerns.
Ash added that the development came at a difficult time in terms of Turkish markets, given the wide current account deficit and a marked deterioration in the financing of the deficit this year.
The benchmark 10-year bond yield rose 25 basis points to 11.34 percent. Prices on Turkish dollar bonds maturing in 2030 and 2036 tumbled 0.8 and 1.0 cent respectively to the lowest since mid-July, according to Tradeweb data.
Among shares hit was flag carrier Turkish Airlines , which dropped 8 percent. TEB Investment said in a research note that the United States accounted for around 10 percent of Turkish Airlines’ sales.
Pegasus Airlines fell 6.5 percent.
Shares in Halkbank, a former head of which has been charged with evading U.S. sanctions against Iran, fell 5.7 percent. Halkbank has said all its transactions have fully complied with national and international regulations. (Additional reporting by Can Sezer; Editing by Dominic Evans and Gareth Jones)