The Justice and Development party (AKP), which has its roots in political Islam, is accused by senior prosecutors of trying to impose Sharia law in militantly secular Turkey, in a case that has shocked and divided the country and undermined the financial markets.

The case also accuses Recep Tayyip Erdogan, the prime minister, Abdullah Gul, the president, and senior AKP leaders of "antisecular activities". Turkey's secular elite - which includes the military, the judiciary and parts of the political opposition - has long accused the party of having a "hidden agenda" to turn Turkey into an Islamist state, an accusation the party rejects.

While the court's decision was expected, analysts warned that the threat to close the AKP, which won a landslide election victory eight months ago, could lead to months of stalemate and a long legal battle at a time when Turkey faces critical decisions on the European Union and economic reform.

"One thing is clear - that political uncertainty will prevail in the remainder of the year," said Ozgur Altug, an economist at Raymond James Securities in Istanbul. Economists at ExpresInvest, a brokerage in Istanbul, said Turkey "has entered a period of high political volatility".

Worries over the economy deepened yesterday when figures showed a sharp slowdown in economic growth in 2007. Gross domestic product expanded by 4.5 per cent for the year, compared with 6.9 per cent in 2006. Analysts are also cutting their forecasts for growth in 2008 and suggest that the weakness of the lira would mean interest rates would have to rise.

Shares on the Istanbul stock market fell by about 3 per cent, while the lira continued to weaken against the euro and the US dollar, amid a rise in bearish sentiment among investors.

The 11 constitutional court judges voted unanimously to hear the case, which means that they believe the AKP has a case to answer. The party has a month to prepare a defence, but observers believe no final verdict can be expected until at least the fourth quarter of 2008, given the highly political nature of the case and the vagaries of the judicial system.

Turkey's constitutional court has ordered the closure of 26 political parties in the past 50 years, and has upheld every case brought before it, which means precedent is against the AKP.

The immediate spark for the case was the easing in February of a ban on wearing the headscarf at universities. The AKP's opponents saw this as a typical example of the party's "majoritarian" approach to government, in which it exploits its huge parliamentary majority to pass laws aimed exclusively at its socially conservative electoral base.

The party's defenders, however, reject these accusations. They say the resort to the judicial system to clip the AKP's wings is unfair and undemocratic. Suat Kiniklioglu, an AKP member of parliament, said in a telephone interview: "This case is being used by the establishment as a last chance to subvert the transformation of this country. It is a sad day for Turkish democracy."

Investors are becoming increasingly worried about the implications of the closure threat to Turkey's economic stability and continued efforts at structural reforms. The country has enjoyed a flood of foreign direct investment in recent years, and it relies heavily on external financing to keep its current account deficit in check.

Court has record of closing parties

Some 26 political parties have been closed in Turkey since the advent of multiparty democracy in the 1950s. The constitutional court has upheld every closure petition so far. Most closures were for non-controversial reasons, such as lack of members and abuse of party funds. 1998 The constitutional court closed the largest party in the parliament, the pro-Islamist Welfare party, on the basis that it had violated constitutional obligations to respect Turkey's strict secular principles. The court seized the ruling party's assets and banned its leaders from politics for five years. 2001 The pro-Islamist Virtue party, the main opposition to the government, was banned on the grounds it had become the focus of anti-secular activities.