The lira has traded in a narrow range since Monday after the central bank last week signaled potential action to stem consumer-price growth that has accelerated to the fastest in 15 years.
Brett Diment at Aberdeen Standard Investments said raising rates would put "Turkey on the slow road to recovering some monetary policy credibility, and that is critical".
The latest rate hike could help ease fears that the central bank cannot act against Erdogan's wishes.
The dual developments on Thursday pushed the lira as high as 6.08 against the dollar and it traded flat on Friday morning, standing at 6.03 to the dollar at 07:28 GMT.
Earlier in the day, Erdogan published an executive decree that forces contracts between two entities in Turkey to be made in liras rather than foreign currencies.
The main share index rose 2.1 per cent, with the banking index up 4.8 per cent. Dollar-denominated bonds issued by the Turkish government rose across the curve.
The lira, which has lost more than 40% of its value this year, had firmed to as far as 6.08 against the U.S. dollar following the rate hike on Thursday, but later weakened slightly in early Friday trade. For now though, this should provide the lira a much needed relief in the short-term.
Economists have argued the nominally independent bank has come under pressure from Erdogan who, only a couple of hours before its decision, launched a blistering attack on the bank and interest rates. "If you say "inflation is cause, the rate is the result", you do not know this business, friend", he added.
Phoenix Kalen, director of EM strategy at Societe Generale, said the market was both pleased and confused by the bank move.
"We will see the result of the Central Bank's independence".
Neil Wilson, chief market analyst at Markets.com said: "This was a definite statement from policymakers, but the risk now is that the market tries to test the central bank's resolve: the horse may have already bolted".
Erdogan called on Turkey's exporters to take advantage of the current levels in foreign exchange rates to increase the volume of exports, and production and employment as well.
There had been indications from the bank that it would raise rates after inflation came in at almost 18 per cent in August, according to official data last week. Subsequently, the lira lost about 25 per cent of its value while authorities have taken a series of steps to support it, with the bank taking liquidity measures and the banking watchdog limiting derivative transactions.
The president also called on the country's people to trust the national currency and convert their savings to lira.