* Lira firms, bond yields dip, shares higher
* Hopes of second investment grade boosted
* Tekstilbank surges 23 percent on sale prospects (Adds Simsek quote, updates figures)
By Daren Butler
ISTANBUL, March 28 (Reuters) - The Turkish lira gained and bond yields dipped on Thursday after Standard & Poor's raised Turkey's credit rating to within a notch of investment grade, while the finance minister said Turkey deserved a higher rating.
S&P cited a rebalancing economy and progress in a peace process with Kurdish militants, but the positive mood was clouded by negative sentiment in Europe due to concerns about a potential run on Cyprus's banks.
"We believe we deserve a higher rating ... if you look at Turkey's CDS spreads and Turkish bond spreads, Turkey is rated significantly higher than what the ratings agencies suggest," Finance Minister Mehmet Simsek told reporters in London.
Turkey's five-year credit default swaps (CDS), used to protect against default, are quoted at around 145 basis points (bps), according to Markit, compared with 165 for BBB-rated Russia and 220 for Romania, which is also rated BB+ by S&P.
Turkish debt spreads are at 228 bps over U.S. Treasuries on the JP Morgan EMBI Global index, only slightly wider than higher-rated Russia's 208 and narrower than Romania's 282 bps.
The lira firmed to 1.8105 to the dollar by 1530 GMT from 1.82 on Wednesday. Against its euro-dollar basket , it firmed to 2.0670 from Wednesday's 2.0711.
Turkey's emerging economy has grown robustly for most of the period since the 2008 financial crisis, in stark contrast to many of its European trading partners, but is at risk from the unrest in neighbouring Syria and elsewhere in the Middle East as well as from its need to import almost all the oil it uses.
It has made steady progress on its credit rating and analysts speculated that the S&P move increased the chances of fellow agency Moody's, which has been more positive on Turkey, raising it to investment grade.
Fitch Ratings has already done so and the country needs a second such rating to join benchmark investment grade bond indexes, allowing many more funds to invest in the country.
"If Moody's is also inspired by the new Kurdish initiative, then the next step would be raising Turkey to investment grade," wrote Tera Brokers Executive Vice-President Ayse Colak.
"This is the development the market is betting on for the last few months and we think Turkey will continue to decouple due to this expectation," she said.
The Kurdistan Workers Party (PKK) militant group declared a ceasefire with Turkey on Saturday after the jailed PKK leader ordered a halt to its decades-long insurgency.
Bond yields, which on Wednesday touched a 2013 high and eased after the central bank signalled it would keep liquidity tight in coming months, fell further after S&P's move.
The benchmark two-year bond yield fell to 6.34 percent from 6.41 percent on Wednesday.
Turkey's central bank appears to be moving away from its focus on protecting the economy against a hot money-fuelled boom in the lira and credit, hunkering down instead for the threat of falling capital inflows if the global mood worsens.
It warned that the current account deficit, Turkey's main economic weakness, was likely to widen in the short term as domestic demand picks up although it said its policy framework would limit further deterioration beyond that.
"Arguably the chances of Turkey achieving the much desired second investment grade rating have increased," Finansbank said in a note, pointing to the current account as the main obstacle.
"Given the agencies' long held strong views about the risks posed by a large current account deficit, it is difficult to see them upgrading Turkey when the deficit is worsening," it added.
Istanbul's main share index rose 1.26 percent to 85,253 points, outperforming a 0.06 percent fall in the global emerging markets index.
Tekstilbank surged 23 percent after its parent GSD Holding, up 22 percent, said it was looking into the lender's possible sale. (Additional reporting by Carolyn Cohn and Lorraine Turner in London, Editing by Nick Tattersall and Stephen Nisbet)