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ANKARA (Reuters) - After a decade and a half of dominance built on Turkeys buoyant growth Tayyip Erdogan has paid a heavy electoral price for an economic slump and will make changes to his government to halt the damage, senior officials in his party said on Monday.

Skyscrapers are seen in the business and financial district of Levent, which comprises of leading banks' and companies' headquarters, in Istanbul, Turkey, March 29, 2019. REUTERS/Murad Sezer

Erdogan saw his Islamist-rooted AK Party lose the capital Ankara in Sundays local elections and appeared set for defeat in Turkeys largest city Istanbul - stunning reversals in two bastions of the party since he took power in 2003.

The setbacks came despite a relentless two-month campaign by the president who addressed up to eight rallies a day, condemned his opponents as terrorists and warned that the vote was a matter of survival for Turkey.

The secularist Republican Peoples Party (CHP) overcame overwhelming media support for the AKP and an environment which European observers said fell short of requirements for genuine democratic elections. The AKP said it would appeal against the results in both cities.

Turkey has experienced years of rapid economic growth under Erdogan, underpinned by a construction boom and cheap loans, that have driven living standards ever higher and ensured the AKP won votes well beyond its core constituency of pious and conservative Turks.

But the recent economic troubles took a toll on party support, two AK Party sources said, after the lira slumped against the dollar last year, inflation jumped to 20 percent, unemployment climbed and the economy tipped into recession.

We saw the impact of the economy in the field, because there was serious unease, one of the sources said, adding that Istanbul accounted for 40 percent of Turkeys economy, meaning that any slowdown would hit the city hard.

In total, three party sources told Reuters Erdogan was likely to implement cabinet changes in response to the setback, but gave no details. There will certainly be changes in some places, one source said.

After Erdogan won elections last June which ushered in a powerful new executive presidency, he also appointed his son-in-law Berat Albayrak as Finance and Treasury Minister. The sources declined to say whether Albayraks position might be affected.

If (Erdogan) cannot create a solution, its inevitable that there will be greater losses in the period ahead, another party source said.

Erdogan appeared to recognize the scale of the challenge ahead, pledging on Sunday night to use the four years until Turkeys next national elections to carry out economic reform based on free market rules. We now have a four-and-a-half-year uninterrupted period to work, he said.

However, economists say the president has made similar reform pledges after all recent elections, before focusing instead on short-term fixes.

This time, his economic choices are narrowed by the conflicting priorities of supporting a fragile currency and restarting a stalled economy. Turkeys benchmark interest rate of 24 percent barely keeps the currency stable and at the same time puts a prohibitive cost on borrowing for Turkish firms.

Ulrich Leuchtmann of Commerzbank said authorities still have some room to increase government spending without driving the lira down further, but signals about Turkeys monetary policy were less encouraging.

Central Bank backdoor tightening over the last week to prevent a repeat of last years lira crisis, when the currency fell 30 percent, did not really increase confidence in their policy making, Leuchtmann said.

During his long tenure - first as prime minister, then as president - Erdogan has drawn strong support from ordinary Turks grateful for the stability and growth he brought, from liberals who backed his efforts to curb Turkeys military, and from Kurdish groups who entered into peace talks with Ankara.

But his main remaining ally now is the strongly nationalist MHP. Many former partners might think twice before resuming an alliance after Erdogans campaign condemnation of opponents he said were linked to terrorists.

In terms of political allies he has boxed himself into a Turkish ultra-nationalist corner, said Turkey analyst Gareth Jenkins.

A crackdown following a 2016 failed military coup has seen more than 77,000 people jailed pending trial, and widespread arrests are still routine. Authorities have suspended or sacked 150,000 civil servants and military personnel.

Erdogans critics accuse him of using the failed putsch as a pretext to quash dissent. Turkish authorities say the measures are necessary to combat threats to national security, threats which Erdogan repeatedly highlighted on the campaign trail.

After campaigning almost yearly for national elections, referendums and local votes, Erdogans horizons have reduced to relatively short-term goals, Jenkins said, casting doubt on his stated plan to avoid bringing forward elections slated for 2023.

Defeat in both Ankara and Istanbul, if confirmed, would also mark a watershed in Erdogans popular appeal - even though his AKP/MHP alliance still succeeded in securing over 51 percent of the vote nationally, leading him to declare an overall victory.

He can apply some brakes, he can slow the decline, Jenkins said. But I think we are seeing another milestone in that decline. I dont see him ever being able to increase his popularity again.

Additional reporting by Karin Strohecker in London; Editing by Dominic Evans and Gareth Jones

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