* Lira hit 3-mnth strongest vs dollar as low CPI figures boosts confidence

* Bonds yields fall further on low CPI data, funding rate

* Shares at 1-1/2 years highest led by banks

(Adds quotes, closing prices)

By Seltem Iyigun

ISTANBUL, Aug 3 (Reuters) - The lira hit its strongest in three months versus the dollar and the benchmark yield dipped 20 basis points to an 18-month low on Friday as falling inflation boosted sentiment for Turkish assets.

The Turkish shares jumped to its 1-1/2 years peak led by a rally in the banking shares following the dip in bond yields.

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. ID:L6E8J32X9

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 1445 GMT, the lira traded at its strongest in three months of 1.7780 versus the greenback TRYTOM=D3 , compared with 1.8022 late on Thursday. It also firmed against its euro-dollar basket TRYBASKETD3= to 1.9864, 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 TR050314TVA=IS closed at 7.49 percent, from a previous close at 7.67 percent.

In intraday trade, the benchmark yield fell as far as to 7.47 percent, its lowest in 18-months, 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.

"Investors are getting more comfortable with the liquidity environment. The central bank has been funding the market at 5.75 percent in decent size recently. That helps bond buying," said Di Luo, an interest rate strategist at HSBC London.

"And of course, this morning's CPI (inflation). When the fear was actually higher food prices amidst higher agriculture commodity prices, they actually came out softer," Luo said. "Our recommendation is to be long the inflation-linked bonds in the belief that inflation will not come down as much as the market expects and easy funding environment also benefit the real assets."

The average lira funding rate fell below 7 percent on Friday, for the first time so far this year. The rate was at 10.8 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 .XU100 closed 2.39 percent up at 65,303 points, its highest since May 18, 2011, outperforming largely a rise of 0.81 percent in the MSCI emerging markets index .MSCIEF .

The rally was led by banking shares .XBANK which jumped 3.43 percent.

"The expectations that Spain will ask for a bailout plan and the rebound after yesterday's fall have affected the shares positively. There is a serious inflows towards emerging assets. The dip in Turkish bond yields triggered buying Turkish banking shares," said Ozgur Yurtdasseven, vice manager of research at Garanti Securities. ($1 = 1.8085 Turkish liras)

(Writing by Seltem Iyigun; Editing by Toby Chopra)

((seltem.iyigun@thomsonreuters.com)(+90 212 350 70 62)(Reuters Messaging: seltem.iyigun.thomsonreuters.com@reuters.net))

Keywords: MARKETS TURKEY/