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LONDON, Jan 28 (Reuters) - Turkey's lira extended gains on Tuesday, supported by the possibility of an aggressive interest rate hike, while other emerging currencies and stocks rose on growing expectations more developing countries would tighten policy.
The benchmark MSCI emerging equity index rose half a percent, having fallen for three straight days to hit a 4-1/2 month low on Monday, while emerging sovereign dollar bond spreads tightened by 3 basis points.
The lira rose almost 1 percent to trade about 7 percent off Monday's record lows, thanks to expectations that Turkey's central bank will raise its benchmark rates at its first extraordinary monetary policy meeting since Aug 2011.
It is expected to raise rates by 225 basis points to 10 percent, according to a Reuters poll of analysts, in what would effectively mark the end of its so-called unorthodox monetary policy.
Expectations are growing that more emerging central banks will tighten monetary policy after India unexpectedly raised its policy rate by 25 bps to counter inflation.
Brazil, South Africa and Indonesia - part of what has been dubbed the Fragile Five economies which have a strong reliance on external capital - may follow suit.
"The trigger for stability is emerging central bank action. If Turkey does something it will help," said Sebastien Barbe, head of emerging market strategy at Credit Agricole in Paris.
"We expect the Turkish central bank to hike rates by 150-200 bps. If they do that it will allow stabilisation in the lira at least in the short term."
Barbe however, like most analysts, does not expect any action from South Africa when the central bank meets later this week. The rand was up 0.3 percent at 11.03 per dollar, off its five-year low hit on Monday.
Tradition Analytics said no rate hike from South Africa would leave the country's assets more exposed.
"The rand and bonds will be increasingly exposed to the current offshore dump of emerging market assets without an adequate interest rate buffer," it said.
Following the rate hike, the Indian rupee rose 0.7 percent to 62.65 to the dollar. The benchmark 10-year bond gained slightly on the day while shares lost 0.2 percent.
New cash injections from China's central bank and a deal from a trust firm that averted a possible default for a wealth-management product also helped stabilise China, which many emerging economies are geared to.
"The 'managed default' successfully staves off a potentially disruptive default during the Chinese New Year period and the hope is that it limits any systemic ripple effects," Deutsche Bank said in a note to clients.
In the long term however, investors are concerned about the effects of China's economic slowdown and the Federal Reserve's plan to scale back its monetary stimulus.
The Fed is expected to announce a further $10 billion cut in its bond buying at a meeting this week.
Ukraine's hryvnia rose 0.3 percent from four-year lows against the dollar after the central bank offered to sell dollars at 8.40.
The currency has been under pressure as concerns intensified about the damage to the heavily indebted economy from two months of unrest.
Prime Minister Mykola Azarov offered his resignation on Tuesday. A faithful lieutenant of President Viktor Yanukovich, Azarov backed the decision in November to walk away from a free trade agreement with the European Union, defending the need for closer economic ties with Russia.
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