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Market turmoil in Turkey after crushing election

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Turkish stocks and currency took a hit on Monday after the ruling Justice and Development Party (AKP) failed to get a majority in parliamentary elections, and analysts warned of a turbulent ride ahead.

The Turkish lira hit a record low of 2.8094 to the dollar on Monday, and Istanbul's stock exchange opened over 8 percent lower, after it became clear that President Tayyip Erdogan's AKP party had fallen short. By 10.45 a.m. the lira was trading around 2.75 to the dollar, and the stocks were 6 percent lower.

Erdogan had hoped the party he'd founded would get two-thirds of the vote – enough to allow it to change Turkey's constitution and enable him to consolidate his hold on power.

But with almost all of the votes from Sunday's election counted, the results showed that the AKP had won 40.9 percent of the vote (compared with 49.8 percent in 2011), giving the party 258 seats in the Grand National Assembly -- 18 short of a majority, according to Turkish news agency Anadolu.

Read MoreTurkey's ruling party falls short

William Jackson, senior emerging markets economist at research firm Capital Economics, said the political uncertainty brought about by the vote added to an "already ugly picture" in Turkey.

"The loss by Turkey's AK Party of its parliamentary majority for the first time since 2002 makes President Erdogan's desire to change the constitution to strengthen the presidency a pipe dream and should in time help to dampen concerns about an increasingly authoritarian streak to policymaking and a more general diminution of checks and balances on government," he said in a note Monday.

Justice and Development Party (AKP) supporters wave party and Turkish flags at Istanbul`s AKP headquarters on June 7.
YASIN AKGUL | AFP | Getty Images

"But in the near term, the coming weeks are likely to be marked by uncertainty over coalition negotiations. This will remain the focus of markets, which have already delivered a resoundingly negative response."

In a further sign of market jitters over the result, the yield on Turkish benchmark 10-years bonds rose to 9.64 percent Monday, from 9.32 percent Friday.

No one party gained a majority in the elections, with the Republican People's Party (CHP) securing 25 percent of vote, the Nationalist Movement Party (MHP) winning 16.33 percent and the pro-Kurdish Peoples' Democratic Party (HDP) getting 13.07 percent of the vote.

Read MoreTurkey election:Erdogan's power hangs in the balance

Turkey's Deputy Prime Minister attempted to reassure markets Monday, saying the AKP would try to form a coalition -- but he also warned that an early election could be called if negotiations failed, Reuters reported.

Jackson said he would not normally attribute too much importance to coalition negotiations and their impact on financial markets, "but in Turkey's case the reaction seems justified."

"As the largest party, AK will have to retain a role in any governing coalition but a combination of its intransigence and the hostility of other opposition to the AK means that finding stable partners will be difficult," he added.

Reform Agenda

There are fears that this political uncertainty in Turkey could thwart attempts by the government to reforms Turkey's economy and return it to its former strength.

Anatole Kaletsky, co-founder and chief economist at research firm Gavekal Dragonomics, told CNBC Monday that the country's economy faced problems ahead.

"The Turkish economy has been in pretty bad straits for the last two or three years, and the currency has been one of the worst performing currencies. There have been a lot of clashes between the government and more Western-orientated central banks too, so I think there are a lot of problems ahead," he said.

But not everyone was so pessimistic, with one Turkish business leader saying the market turbulence marked "temporary turmoil in the markets" and that reforms depended on which coalition was formed.

"I think the AKP will be very open to a coalition in the coming days and if the AKP, which is a reformist party, is in a coalition then I think we can be more optimistic about the reform agenda in the coming days," Artunç Kocabalkan, chief executive of the İstanbul Financial Center Initiative, told CNBC Monday.

- Additional reporting by CNBC's Hadley Gamble.

- Written by CNBC's Holly Ellyatt, follow her on Twitter @HollyEllyatt. Follow us on Twitter: @CNBCWorld