(Updates with closing prices)

     By Mark Bentley

     ISTANBUL, Sept 17 (Reuters) - The Turkish lira hit a record low and shares tumbled on Monday while bond yields rose as investors fretted over Wall Street's fate and the effect any U.S. retaliatory strikes for last week's attacks might have on Turkey's fragile economy.

     ``Right now the hot issue is what's happening in the world, if there's going to be a war,'' said Tolga Atac of Bayindir Securities in Istanbul. ``Until we see how the U.S. retaliates, and how U.S. markets react, it's going to be very hard for Turkey...we were at a vulnerable stage anyway,'' he said.

     The Turkish lira currency closed the day at a record low close of 1,549,000 to the dollar on the central bank-brokered spot market, just off an intraday low of 1,550,000 and more than four percent down on Friday's 1,486,000.

     The currency had hit 1,550,000 to the dollar in late morning, dipping under a marker set by the central bank which sold $20 million at an average 1,549,000 lira in an earlier auction of dollars.

     Shares on the main index staged a recovery from morning losses of more than 10 percent, ending 2.15 percent down at 7,766.92 points while yields on the busiest paper maturing on March 6, 2002 rose over three points to 96.44 percent.

     Turkey -- a NATO-member -- is implementing a $15.7 billion IMF-backed rescue pact that brokers say could be blown off course if conflict in the region erupts, undermining its economy even further.

     Economy Minister Kemal Dervis issued a stark warning of the damage global turmoil could do to Turkey, which needs lower borrowing costs and foreign investor confidence to help extricate it from financial crisis.

     ``Turkey's strategic importance for the European Union and NATO is rising and within this strategic framework Western allies should consider the cost that Turkey will have to bear,'' Dervis told reporters in Ankara.

     Analysts said the equities recovery, which followed a 50 basis point U.S. rate cut, was fragile while fears over what effect the U.S. response would have on Turkey persisted.

     ``Local players have bought into the exchange a little...This is short term. I don't expect the buying to continue while unpredictability in the Middle East region continues,'' one local broker said.

     PROGRAMME IN JEOPARDY?

     Analysts warned that falls in many leading shares indicated that Turkey's economic programme might be in jeopardy.

     ``It doesn't end with a fall in the exchange...The economic programme has taken a huge knock from these developments,'' said Serdar Karatepe of Polen Securities.

     Brokers said the failure of leading Turkish bank Garanti Bankasi to strike a deal yet with Italian bank IntesaBci had frayed investor nerves further.

     ``The decision taken at the last Intesa board meetings related to the partnership talks between Intesa and Garanti has also contributed to sales on the bourse,'' Karatepe said.

     Turkey hoped a deal between Garanti and the Italian bank would help restore foreign investor confidence in Turkey's fragile economy, but Intesa on Friday cited the new climate caused by the U.S. attacks as a cause to postpone a decision on the possible 30-35 percent purchase of Garanti to a later date.

     Garanti said on Monday talks continued, but its shares fell seven percent, recovering from a 22 percent fall earlier in the day.

     Brokers also said the Dervis announcement of a possible postponement of a Eurobond issue set for September had fuelled investor panic over the future of the economic programme.

     Turkey must service some 34,800 trillion lira (around $24 billion) in debt during the rest of the year.

     Sharp rises in interest rates from levels in the low eighties prior to the U.S. attack have raised concern about the country's ability to service its debts at reasonable cost.

     Turkey has targeted average interest rates of 91 percent for domestic debt auctions in 2001 -- a target analysts say looks less achievable by the day.

     Investors worry that foreign borrowing for a country so close to the Middle East could become expensive as well, if indeed foreign banks are willing to lend at all -- Turkey must refinance some $2.2 billion in foreign loans it has already secured over the next six months.

     Additionally there is concern that Turkey's status as a NATO member with U.S. military planes on its soil could give it a high profile in any possible retaliation.
^ REUTERS@