Turkish assets firm, pressure to hike rates persists
* Lira firms from record lows but remains under strain
* Next monetary policy meeting on Jan. 21 closely watched
* Modest U.S. data points to very gradual bond buying taper
By Dasha Afanasieva
ISTANBUL, Jan 7 (Reuters) - Turkey's lira recovered from Monday's record lows on Tuesday, supported by weaker-than-expected U.S. economic data that raises hopes of a slower tapering of bond buying, but was still under pressure from louder market calls for interest rate hikes.
The pace of growth in the U.S. services sector slowed for a second month in December with business activity expanding at a lower rate and new orders contracting, according to the Institute for Supply Management on Monday.
The Federal Reserve will begin winding down, or tapering, its $85 billion-a-month money-printing programme this month, and emerging markets are seeing a reduction in cheap capital inflows as a result. Turkey is among the most vulnerable with its huge current account deficit and its reliance on external financing.
The lira traded at 2.1700 by 1144 GMT, stronger than 2.1818 late on Monday and Monday's record low of 2.1950. It weakened 17 percent in 2013.
While the lira has hit new lows with the real effective exchange rate falling in November and consumption tax hikes announced on Jan. 1 expected to boost inflation, the central bank has stuck to its unorthodox method of supporting the currency mainly through dollar sales.
Finance Minister Mehmet Simsek said on Tuesday that Turkey was taking measures to keep domestic demand at reasonable levels without hiking interest rates.
While analysts agreed that the bank remains reluctant to raise rates, some said a hike was becoming more likely at the next monetary policy committee (MPC) meeting on Jan. 21.
"The recent fall in the lira may now force its hand (to increase rates," a note from Capital Economics said adding that current policies to support the lira are not functioning as hoped.
"This month's MPC decision looks like being an extremely close call. But on balance, we now think it is more likely than not that the central bank will raise its overnight lending rate."
Turkish assets have been under additional pressure since Dec. 17 when a wide-ranging graft probe began with a series of dawn raids and arrests and has led to the resignation of three ministers and the reported dismissal of hundreds of police officers.
It has revealed fractures within the ruling AK Party, and unnerved investors in the run-up to local elections this year, prompting a sharp selloff of Turkish assets.
The main Istanbul stock index was up 0.17 percent at 68,137.96 points outpacing the main emerging market index which was down 0.18 percent.
The yield on Turkey's 10-year benchmark bond fell to 10.05 compared to 10.3 percent late on Monday. (Editing by Alison Williams)
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