UPDATE 1-Turkish assets firms, graft feud weighs
* Lira firms from Thursday's record lows
* Weaker-than-expected U.S. jobs data lifts lira
* Local elections key for political risk, monetary policy
* 10-yr bond yield below 10 percent for first time in 2014 (Updates for closing figures, U.S. jobs)
By Dasha Afanasieva
ISTANBUL, Jan 10 (Reuters) - Turkish assets recovered some losses on Friday as weaker than expected U.S. jobs data reduced fears of a deeper cut in U.S. stimulus, but remained under pressure from a corruption scandal shaking the government.
U.S. employers hired the fewest number of workers in almost three years in December, nonfarm payrolls showed on Friday, surprising markets and helping lift the Turkish lira off Thursday's record lows.
A deepening feud between Prime Minister Tayyip Erdogan's government and the judiciary and police has weighed on markets since the corruption investigation came to light last month.
The inquiry has led three ministers to resign and damaged the ruling party ahead of elections this year as well as causing the lira to repeatedly weaken to record lows.
Erdogan has cast the affair as a bid by U.S.-based Turkish cleric Fethullah Gulen to smear his AK Party before a local election in March and a presidential race five months later, in which he is expected to stand.
In the first major poll since the scandal broke, the popularity of the ruling AK Party slipped but it remains well ahead of rivals.
"Against these myriad unknowns it is only reasonable to incorporate a much higher political risk premium than we have been accustomed to since 2002," said Inan Demir, chief economist at Finansbank.
Morgan Stanley said in a note to clients on Thursday that it saw significant downside risks to economic growth because of the political uncertainty and said those risks were still not reflected in Turkish asset prices.
The lira firmed to 2.1660 against the dollar by 1547 GMT from 2.1850 late on Thursday, when it touched an all-time low of 2.1980 in early trade.
Markets had feared that strong U.S. jobs numbers would lead to sharper cuts in the U.S. stimulus that has flooded emerging markets including Turkey with cheap money.
Turkey is particularly vulnerable to cuts in the $85 billion monthly asset buying, which is set to be reduced by $10 billion this month, because of its large current account deficit.
Despite the pressure on the lira, Turkey's central bank has so far refused to raise interest rates for fear of crimping growth, attempting instead to support the lira through forex auctions and tightening monetary conditions by cancelling repo auctions that strategies analysts say have a limited shelf life.
The bank has said it plans to sell at least $6 billion at forex auctions by the end of this month and has already sold more than half that amount, depleting its forex reserves.
The real average cost of funding for banks, running at around 7.12 percent, is meanwhile very close to the maximum it can reach without a change in headline rates. The central bank kept its main one-week repo rate at 4.50 percent, its borrowing rate at 3.50 percent and its overnight lending rate at 7.75 percent at its last meeting in December.
Stocks rose after two days of losses with the Istanbul index closing up 2.26 percent at 67,912 points, outperforming the main emerging market index, which rose 0.72 percent.
The yield on Turkey's 10-year benchmark bond fell below 10 percent for the first time since the end of last year, closing at 9.95 percent from 10.04 percent late on Thursday. (Editing by Nick Tattersall and Tom Heneghan)
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