* Garanti leads banking rally
* Portugal downgrade sees funds flowing to Turkey
* Stocks could be hit if reform process rocky
(Adds quote, closing prices)
ISTANBUL, March 25 (Reuters) - Turkish shares surged 3.5 percent on Thursday, close to an all-time peak, boosted by demand for banks, easing political worries and big cashflows from less favoured emerging markets.
Most actively traded Garanti Bank (GARAN.IS) led the charge with a jump of 5.7 percent. Sources close to the situation said earlier General Electric (GE.N) had received non-binding bids for its 20.85 percent stake in Garanti.
The main Istanbul share index .XU100 ended the day up 3.46 percent at 57,044.66 points, boosted by a 5.27 percent rally in the banking sector .XBANK, which account for more than half of the index weighting.
HSBC Portfolio General Manager Namik Aksel said the gains were driven by banks on positive expectations for the sector.
“A narrowing of banks net interest margin was expected. But in January this was not the case. There was buying which spread from Garanti to other banks. There are both domestic and foreign buyers,” Aksel said.
The index hit a near three-year high and is just 3 percent off its all-time peak.
“We are seeing a huge cash inflow into Turkey, as investors are switching from other emerging markets such as Russia. The downgrade of Portugal has also led investors to single out Turkey,” said a trader at Is Invest.
The yield on the benchmark Nov. 16, 2011, bond <0#TRTSYSUM=IS> fell to 8.93 percent, a fresh monthly-low, from 8.96 percent a day earlier.
The lira IYIX= also gained, trading at 1.5380 to the dollar on the interbank market, compared with 1.543 a day earlier.
Positive momentum outweighed lingering concerns about a dispute between the government and judiciary over constitutional reform, although analysts cautioned that any negative developments could see the index suffer a sudden downward shock.
The government wants to amend the constitution to introduce more control over the appointment of judges and prosecutors, a move it says is necessary to meet European Union membership criteria. It has said it will submit its reform draft to parliament before the end of the month.
Critics of the government say the reforms are aimed at consolidating the AK Party’s power.
The party lacks enough votes in parliament to amend the constitution outright, so the proposed amendments would likely face a public referendum, a move that could escalate tensions.
The Turkish economy is expected to have contracted around 6 percent last year, but the government forecasts it will grow 3.5 percent in 2010, and could easily surpass that forecast.
Data released late on Wednesday gave a mixed picture of the Turkish economy [LDE62N25N].
Turkish capacity use rose only slightly in March to 67.9 percent, but a manufacturing confidence index hit its highest level since August 2007, data showed on Wednesday.
“There has been little improvement in capacity utilisation in recent months. The headline figure has been fluctuating at around 68 percent - well above the extreme lows posted during the crisis but still below the historical 77.5 percent average, said economist Ahmet Akarli at Goldman Sachs in a note.
While there was doubtless still excess capacity in manufacturing he said the rise in the business confidence index suggested a solid rebound in industrial production and capacity use in the coming months. (Additional reporting by Ebru Tuncay and Evren Ballim, writing by Alexandra Hudson; editing by David Cowell)