UPDATE 2-Turkish markets tumble as protests unsettle investors
* Shares fall as much as 8 percent
* Lira at weakest since January 2012
* Bond yields at highest since start of April
By Daren Butler
ISTANBUL, June 3 (Reuters) - Turkish shares fell 6.67 percent, the lira spiralled to 16-month lows and bond yields jumped on Monday as investors were given their first chance to respond to violent anti-government protests over the weekend in cities across the country.
Protests, which began last week with a demonstration to save an Istanbul park from development, have widened into a broad show of defiance against the ruling AK Party. Tens of thousands of Turks took to the streets on Sunday and many clashed with riot police in major cities.
The streets were quieter on Monday morning after another night of protests and violence in Istanbul, Ankara and other cities, which have seen police battle protesters with tear gas.
Prime Minister Tayyip Erdogan called for calm, urging people not to be provoked by demonstrations he said had been organised by "extremist elements". His remarks at a Monday news conference did not reassure investors concerned that unrest would go on.
"The risk clearly is that this all just drags on and then the danger is that violence racks up a notch taking this to an entirely different level - further heightening tensions and entrenching positions," said Timothy Ash, head of emerging markets research at Standard Bank.
He said Erdogan's comments did not seem to show the prime minister adopting a softer line and indicated he would not bow to pressure, which Ash described as "not very encouraging".
"I would expect the Turkish authorities, particularly the central bank, to be active in re-assuring investors. For the central bank, the problem is that the lira was weak last week on global market concerns," he said.
The impact of the violent demonstrations on shares was exacerbated by a sell-off in emerging markets in response to signs a U.S. economic recovery could induce the Federal Reserve to scale back its money-printing.
The main Istanbul share index dropped 6.67 percent to 80,253.60 points, having fallen as much as 8 percent. The lira weakened to 1.8920 against the dollar, having earlier hovered around the 1.9 level, its weakest since January 2012.
The two-year benchmark bond yield rose to 6.48 percent from 6.07 percent late on Friday. The yield on the 10-year bond yield climbed to 7.12 percent from 6.84 percent.
The volume of trade on the bond market was extremely low, however, with big banks behaving cautiously.
"We can see major banks are not trading bonds. Their bond portfolios are very large, they don't want to price such a big movement," said one senior banker. "The central bank has not yet shown what sort of a step it will take."
The negative sentiment undermined market optimism generated by a second investment grade rating, which Turkey earned from Moody's last month.
The cost of insuring Turkey's debt against default rose to two-month highs. Turkey's five-year credit default swaps rose 12 basis points to 143 bps, according to Markit, their highest since early April, wiping out improvement since May 16 when Moody's upgraded Turkey to Baa3.
Central Bank Governor Erdem Basci said on Friday the bank may implement additional monetary tightening in the short term, after cutting interest rates several times since September to aid growth.
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