UPDATE 1-Turkish assets firm, inflation eyed

* Markets digest Turkey-Armenia normalisation efforts

* Banking index leads shares higher

ISTANBUL, Sept 1 (Reuters) - Turkish shares rose on Tuesday as investors weighed up low inflation and interest rate cut expectations and digested news Turkey and Armenia were moving closer to forming diplomatic ties.

The lira also gained while bond yields rose slightly.

Ending historical animosity between the two countries is seen as a boost to Turkey's European Union membership ambitions.

Istanbul's main share index .XU100 closed 0.83 percent higher at 46,935.62 after falling more than 2 percent on Monday. The index has gained 75 percent so far this year.

Banks led the gains, with the banking index .XBANK ending up 1.25 percent. Banks make up around half of Istanbul's blue chip index.

"We were expecting the index was going to rebound today because yesterday most of the banks closed a little bit higher than their 22-day moving averages, which was a good sign for further movement," said Tuncay Tursucu, head of research at Meksa Securities.

"But we think all of the rebound has happened and that the index will continue to trade range-bound between 47,700 and 46,300 in the next few days," he said.

The lira IYIX= closed at 1.5045 against the dollar in interbank trade, virtually flat compared with a close of 1.5050 on Monday, but firmed to 1.5000 in Wednesday-dated trade. The lira has gained some 18 percent from its March lows but is expected to remain range-bound in the short term.

Turkey and Armenia said late on Monday they sign accords within six weeks envisaging the establishment of diplomatic ties and development of bilateral relations.

But investors are expected to wait for concrete moves that would re-open the countries' shared border, closed since 1993.

"The developments between Armenia and Turkey is not having a significant impact on stocks yet ... but concrete developments would be good especially regarding our European Union path," said Tursucu.

The benchmark bond <0#TRTSYSUM=IS> rose to 9.73 percent from the previous day's close of 9.67 percent. It has hit successive lows over the past weeks on expectations the central bank would keep cutting interest rates, which have been slashed by 900 points since last November.

Economic data on Tuesday reinforced expectations of low inflation and interest rate cuts, analysts said.

Exports fell 29.8 percent year-on-year in August, according to an exporters group, while Istanbul retail prices were up 0.19 percent from a month earlier in August for an annual rise of 7.54 percent according to the city's chamber of commerce (ICC).

"The ICC data have made us more confident on our below-consensus inflation call," said JP Morgan economist Yarkin Cebeci. National inflation data is due on Sept. 3.

"This should make the Turkish Central Bank even more comfortable in cutting rates. We expect a 50 basis point cut this month and a final 25 basis point cut in October," he said. (Reporting by Thomas Grove; Editing by Victoria Main and Andy Bruce)