Turkish shares were more than one percent up, outperforming the emerging markets index after falling slightly on previous day following the global sell-off due to disappointing comments from the European Central Bank over potential policy action.
Turkey's consumer price index fell 0.23 percent month-on-month in July, compared with a Reuters poll forecast of a 0.10 percent fall, supporting expectations that the central bank will ease monetary policy in coming months while maintaining a cautious stance.
Monthly inflation has now fallen for the past three months, though on an annual basis inflation it rose to 9.07 percent, much higher than the bank's year-end target level of 5 percent. The central bank now predicts year-end inflation of 6.2 percent.
By 1124 GMT, the lira traded at 1.7849 versus the greenback , from 1.8022 late on Thursday. It also firmed against its euro-dollar basket to 1.9883, from 1.9953.
"The fact that July inflation data showed the inflation trend is in line with the central bank's projections boosted confidence for Turkish assets. This rises the central bank's credibility and supports the lira," said Isik Okte, strategist at Halk Invest, adding that the global firming of emerging currencies also underpin the Turkish currency.
Turkey's two-year benchmark bond yield fell to 7.51 percent, from a previous close at 7.67 percent, extending its gains after the central bank's comments to ease its monetary policy gently and its decision to cut the year-end inflation forecast on July 26.
The central bank lowered its year-end inflation forecast to 6.2 percent last Thursday, from 6.5 percent.
Since earlier last week, the total decline in the benchmark yield reached nearly 45 basis points.
"The central bank gained serious credibility after July inflation figures indicated the trend in inflation is as the central bank has desired it to be. The lower lira funding rate is also an important factor which supports the bonds," said an Istanbul based fixed-income trader.
Analysts said the average lira funding rate fell below 7 percent on Friday, far below a level of 10.5 percent in late May, when the central bank applied additional tightening to tackle inflation. This helps banks to have a lower level of funding costs, allowing them to buy bonds.
Istanbul's main share index was 1.02 percent up at 64,430 points, outperforming largely a rise of 0.02 percent in the MSCI emerging markets index.
"Today's rise in Turkish shares looks like a rebound of the yesterday's fall. But if the index can't stay above 64,000 we can see further sales for profit taking. The reason why Turkish shares outperform emerging peers is the pricing in of a possible upgrade of Turkey's rating to investment grade," said Erdem Kayli, vice president at Tekstil Invest.
Moody's raised Turkey's ratings to Ba1 with positive outlook on June 20, 2012, one notch below investment grade, citing a significant improvement in the country's public finances.