* Last week's rate hikes to hit banks' profit margins - Moody's
* Sharp monetary tightening may curb economic growth, it says
* Says rate hikes may harm credit quality of existing loans
ISTANBUL, Feb 3 (Reuters) - Turkey's sharp interest rate hike will squeeze the profitability of its banking sector through higher funding costs and worsen the quality of bank assets, ratings agency Moody's said on Monday.
Last week Turkey's central bank dramatically hiked all its key interest rates at an emergency midnight policy meeting as it fought to defend the country's crumbling currency.
For months, the ruling Justice and Development (AK) Party had publicly discouraged a rate hike, wary of its impact on growth in the run-up to local elections in March.
"CBRT's (the central bank) measures will constrain banks' revenue generation and profitability," Moody's said in a sector comment.
"We expect that downside risks to Turkey's economic growth from the sharp monetary tightening will harm the credit quality of existing loans and limit opportunities for lending growth," it said.
Unsecured consumer loans and loans to small and medium-sized enterprises are most vulnerable because of their short terms and floating interest rates, the ratings agency said.
Moody's said Turkish banks' profitability indicators have been among the strongest since 2008 versus selected regional and global peers but still the recent rate moves were likely to negatively affect their asset quality.
The agency cited a structural mismatch in loan maturities in the banking sector; with the banking system funded by short-term deposits maturing within three months versus assets with longer-term maturities.
"Because of the structural maturity mismatch, banks' margins will contract from the sudden increase in funding costs," Moody's said.
Turkish Economy Minister Nihat Zeybekci downplayed the risks on economic growth because of the rates hikes. He said on Monday he did not see any risk to the 4 percent end-year growth target.
Moody's also said lira depreciation will affect borrowers' ability to repay loans, as around half of corporate lending is denominated in foreign currency.
Istanbul's banking stocks index, which is heavily weighted in the main index, hit a 52-week low last Wednesday, the first day of trading after the rates hikes.