UPDATE 3-Turkey cuts lending rate, hints at more action

* Lending rate cut more than expected

* Signals further easing

* Adjusts new policy tool to manage liquidity (Adds analyst comment)

By Seda Sezer and Seltem Iyigun

ISTANBUL, Sept 18 (Reuters) - Turkey's central bank cut its overnight lending rate for the first time in seven months on Tuesday and hinted it could do more to try to cushion a slowdown in economic growth.

The bank cut the upper boundary of the interest rate corridor by 150 basis points to 10 percent, a bigger cut than economists had forecast and took steps to keep loan growth in check to avoid overheating.

It adjusted a new policy tool to try to control flows of money into the country that could result from stimulus action by the U.S. and Europe's central banks to revive the global economy.

Turkey's economy was the fastest-growing in Europe last year, expanding by 8.5 percent, but growth has slowed this year as domestic demand has weakened and policymakers have been trying for a soft landing.

The central bank has had some success in a battle to bring down inflation, giving it scope to cut rates, but the country also has a large shortfall on its current account deficit.

Policymakers left the door open for more action.

"The committee ... said narrowing the interest rate corridor will support financial stability. A measured step in the same direction could be taken in the coming period if seen as necessary," the central bank said in a statement after its monthly monetary policy committee meeting.

The central bank kept its main policy rate, the one-week repo rate, at 5.75 percent, and its overnight borrowing rate at 5 percent, as expected.

Economists in a Reuters poll had expected a cut of 100 basis points in the upper boundary of the central bank's interest rate corridor, which now stands at 11.5 percent. None expected the main policy rate - the one-week repo rate - to be cut.

"It looks like it's quite aggressive as a move. It's going to be very bullish for fixed income. I am turning much more nervous for the lira ... clearly they are saying they don't want a strong lira," said Benoit Anne, head of emerging markets strategy at Societe Generale.

"It is a very strong signal sent to the market."

The yield on Turkey's benchmark two-year bond fell to 7.22 percent from 7.30 percent shortly before the central bank decision was announced and it closed at 7.32 percent. The lira firmed to 1.7925 against the dollar from 1.8030 before the decision.

The central bank has kept the one-week repo rate at an all-time low of 5.75 percent for more than a year and has used the rate corridor - the gap between its overnight lending and borrowing rates - to tighten monetary conditions.

Turkey's annual inflation rate fell to 8.88 percent in August from above 11 percent in April, while the economy grew a lower-than-expected 2.9 percent in the second quarter.

The bank said it expected the fall in inflation to be more significant in the fourth quarter and forecast a gradual narrowing in the current account deficit.

GLOBAL LIQUIDITY

In August, the bank had introduced a new policy tool - reserve option coefficients (ROCs) - expected to play a growing role in its strategy as it tries to manage lira volatility in the face of an expected rise in foreign capital inflows.

The coefficients, which the central bank revised on Tuesday, mean that lenders will have to provide proportionally more foreign exchange to the central bank the more lira reserves they choose to hold in foreign currency.

The policy, which the central bank says has not been used anywhere else in the world, will allow it to increase its forex reserves and free up lira liquidity without the need for direct intervention in the currency market.

"The central bank is raising reserve option coefficients as they want to avoid an excess in pace of loan volume growth due to abundant global liquidity," Haluk Burumcekci, an economist at EFG Istanbul Securities, said.

"This will also help the central bank to increase its forex reserves as banks will choose to put forex in the central bank instead of the lira because of the lower costs."

Banks holding up to 40 percent of their lira reserves in forex will now have to provide the forex equivalent of 1.3 times the lira amount, from a previous coefficient of 1.1.

Between 40-45 percent, they will be required to provide 1.6 times from 1.4 times previously. The ratio increases for each additional 5 percent up to the 60 percent maximum.

A similar gradual scale applies to lira deposits held in gold with the central bank. That scale was left unchanged on Tuesday. (Writing by Nick Tattersall; Editing by Jane Merriman)