* Lira, bonds gain on narrower trade deficit
* Benchmark yield dips to 1-1/2 year low
* Shares fall after Garanti results disappoint (Adds closing prices, fresh quotes)
ISTANBUL, July 31 (Reuters) - The lira strengthened and Turkey’s benchmark bond yield fell to its lowest in 1-1/2 years on Tuesday after data showing a smaller-than-expected trade deficit pointed to continued improvement in the external balance.
The lira was also supported by demand from companies for tax payments.
Shares fell more than 1 percent, held back by a drop in Garanti bank, the most actively traded stock, after the bank disappointed with lower-than-expected second-quarter earnings.
By 1443 GMT, the lira stood at 1.7913 versus the dollar, after hitting its strongest since June 20 at 1.7890 in earlier trade and compared with 1.8020 late on Monday.
Against a euro-dollar basket the lira stood at 1.9977, compared with 2.0041 late on Monday. The currency hit its strongest in a year at 1.9932 in early trade.
“The lira firmed as investors continued to buy Turkish bonds and local companies sold dollars to pay their August taxes. The lira needs of companies may support the lira in the next couple of days,” said the treasury manager of a brokerage house in Istanbul.
The lira found support after data showed Turkey’s trade gap, a major weakness, narrowed to $7.18 billion in June from $10.26 billion a year earlier, lower than a forecast deficit of $8 billion in a Reuters poll.
Turkey’s benchmark March 2014 bond yield fell to 7.61 percent in intraday trade on Tuesday, its lowest in 1-1/2 year and extending a decline that began after the central bank cuts its inflation forecast and indicated a gentle easing of its policy stance last week.
The benchmark bond yield was at 7.62 percent at the close, from a previous 7.77 percent.
“The prospects of a lower inflation and the better-than-expected trade data supported bonds. The fall in the central bank’s average funding rate also gives more room for banks to buy bonds. I expect the yields to remain flat for sometime,” said the manager of a fixed-income desk at a bank in Istanbul.
The central bank’s average lira funding rate stands between 7-7.5 percent, far below a level of 10.5 percent in late May when the bank had applied additional tightening to tackle inflation.
Turkish inflation data is due on Aug. 3. The central bank lowered its year-end inflation forecast to 6.2 percent last Thursday, from 6.5 percent.
Annual consumer price inflation dipped to 8.87 percent in June, from above 11 percent in April but still stands higher than the central bank’s year-end target of 5 percent.
Istanbul’s main share index closed 1.19 percent lower at 64,259 points, underperforming a 0.6 percent rise in the MSCI emerging markets index.
Garanti Bank posted a 23.8 percent drop in net profit year-on-year to 718.5 million lira ($399 million) for the second quarter, hit by higher provisions and missing forecasts. Its shares fell 2.8 percent to 7 lira.
Prior to Garanti’s results, optimism over second-quarter bank earnings had supported the main share index, which closed on Monday at its highest level since May 18, 2011.
Turkish lenders Akbank and Yapi Kredi are expected to release second-quarter earnings by Aug. 3. (Writing by Seltem Iyigun; Editing by Stephen Nisbet and Susan Fenton)