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* Measure of implied volatility at highest since last September
* Central bank tweaks help reverse last week's steep losses
* Expected rate cut might be delayed - traders (Updates prices)
ANKARA, March 26 (Reuters) - The Turkish lira firmed again on Tuesday in volatile trade, as a series of "back door" actions by the central bank succeeded in erasing most of last week's steep losses, even as expectations dimmed for interest rate cuts in the months ahead.
A measure of the lira's implied volatility spiked on Tuesday to its highest weekly reading since September, when Turkey was in the throes of a currency crisis that, at its worst, sliced some 30 percent from the value of the lira.
Turkey's central bank kept two auctions shut on Tuesday to underpin the lira against a growing tide over the last six months of Turks losing confidence and turning to foreign cash.
At 1802 GMT, the lira stood at 5.3950 against the U.S. dollar, strengthening around 3 percent from Monday's closing level of 5.5520. It had touched as much as 5.38 in late evening trade after initially easing to 5.5949 in the morning.
Beginning late on Monday, Turkish banks started to keep lira swap market transactions in London well below a 25-percent limit set by the banking watchdog, four sources with knowledge of the matter told Reuters. It was not clear how much of the limit was being used.
Traders said this caused the lira overnight swap rate in London to soar to 330 percent, and the weekly swap rate to 125 percent, according to Refinitiv Eikon data. Last week, these rates stood at 22 percent and 24 percent respectively.
The lira fell sharply on Friday and closed last week at 5.7625 to the dollar, its worst closing value since October. The selloff came just over a week before local elections in which President Tayyip Erdogan is campaigning hard for his AK Party.
The government's response at the weekend, including threatening bankers and investigating their foreign exchange operations, rattled investors in a way that could spell trouble for an economy in recession and reliant on foreign funding.
The yield on Turkey's benchmark 10-year bond rose to 18.06 percent, from 17.35 percent on Monday. The main BIST 100 share index dipped 1.06 percent Tuesday after two days of losses.
RETHINKING RATE CUTS?
On Monday the central bank made several tweaks to lira liquidity, chiefly halting funding through one-week repos at 24.0 percent, its policy rate. It also began lending at 25.5 percent from the overnight repo and depo windows.
Analysts said the tightening moves - called "back door" actions because the policy rate was left unchanged at 24 percent, where it has been since September - could dim expectations that the central bank will cut rates by mid year, as a Reuters poll in February predicted.
"These two seem completely opposite to each other," said a foreign exchange desk trader in a bank. The latest moves mean the central bank "is now making an additional tightening by 150 basis points," the trader said.
Since the lira's initial plunge on Friday, money market traders appear to have boosted odds of rate hikes later this year, after the cost of borrowing wholesale saw its biggest jump on record on Friday and headed higher on Monday. See: https://tmsnrt.rs/2HFCPtg
Some investors and officials warn that such wholesale markets can be misleading due to their limited size, especially after such volatility and rapid-fire policy changes. The government has promised "single-digit" rates as soon as possible.
Yatirim Finansman Securities said a rise in banks' cross-currency swap limits with the central bank boosted liquidity by 5 billion lira on Monday. In yet another tweak, the central bank also stopped regular $500-million overnight forex lending.
These measures pushed up the average cost of funding to 24.31 percent on Monday from a previous 24.0 percent. Bankers forecast it would rise to 24.60 percent on Tuesday.
But Yatirim Finansman said the real effects of the change in liquidity policy were more apparent in the offshore market for lira. The overnight forward implied (USDTRY) yield shot up to over 90 percent at the end of Monday's trading session, it said.
"This coupled with much lower global core yields and higher EMFX, squeezed offshore short lira positions, allowing lira to pare back some of Friday's losses," it said.
"Going forward, we would watch whether the astronomic rise in relatively thin size of offshore lira market would be enough to stabilize the currency," the note added.
(Additional reporting by Daren Butler Editing by Jonathan Spicer and Gareth Jones)