* Central bank move stuns investors after inflation jumped
* Bank seen as focusing on slowing H2 growth
* Investors worry about Erdogan's policy influence
* Bank shares hammered, default insurance costs rise (Adds Albayrak statement, investor comment, markets)
By Ezgi Erkoyun and Humeyra Pamuk
ISTANBUL, July 24 (Reuters) - Turkey's central bank left interest rates on hold on Tuesday, confounding market expectations of a rise and sending the lira sharply weaker, in its first policy decision since President Tayyip Erdogan was re-elected with new executive powers.
The bank, already the focus of investors' concern over its perceived lack of independence from Erdogan, cited signs of weakening domestic demand as the reason for keeping the benchmark rate at 17.75 percent.
Banks shares were also hammered while dollar bond yields rose, as did the cost of insuring Turkish debt against default.
The bank's policy meeting was widely seen as a test of how it would act under the new executive presidential system, which went into effect this month and gave Erdogan sweeping new powers. In one of his first acts since being sworn in, Erdogan named his son-in-law Berat Albayrak as finance minister.
The rate decision appeared at odds with comments from Albayrak, who said over the weekend he would not fight the financial markets.
The lira, which has lost about 20 percent of its value this year, weakened as far as 4.94 against the dollar following the decision, from 4.7605 directly before. It was at 4.8670 at 1418 GMT, nearly 3 percent weaker on the day.
Erdogan wants lower borrowing costs to fuel economic growth, and investors' worries that his influence over monetary policy is weakening the bank's ability to fight inflation have prompted the lira sell-off. Inflation hit 15.39 percent in June, its highest level in 14 years.
"We like to hear policymakers telling us that they will work with markets and bring inflation down and respect the independence of the central bank, but we want to see these words backed up with action," said Tilmann Kolb of UBS Wealth Management.
"We have seen constantly worsening inflation dynamics... and in that situation you would have expected the central bank to act," he said.
Fifteen of 16 economists in a Reuters poll had forecast a rate rise, with an increase of 100-125 basis points considered the most likely option.
The sole economist to predict no change, Muammer Komurcuoglu of Is Invest, said the central bank was probably concerned about growth in the second half of this year.
"External demand maintains its strength, while signs of deceleration in domestic demand become more visible," the bank's monetary policy committee said in a statement, adding it "might be necessary" to maintain a tight monetary stance for an extended period.
The central bank has raised rates by 500 basis points since late April in an effort to put a floor under the currency.
"Utterly mystifying," said Paul McNamara, emerging markets investment director at GAM Investments in London, describing the bank's decision. "Anything that undermines the lira is likely more dangerous than hikes."
"While the (central bank) is nominally independent, it's unlikely that this decision isn't politically influenced. At the moment, the damage from higher yields and weaker lira is much worse than 125bps in rate hikes would have been."
The index of bank shares tumbled nearly 4 percent - Erdogan has told lenders they must ensure customers can borrow cheaply - while Turkey's dollar bonds were likewise hit.
The central bank's reluctance to act is also likely to focus more attention on Turkish companies' debt. The lira sell-off could "cause strain on corporate banks' balance sheets due to the level of foreign currency debt", said William Jackson of Capital Economics.
As of April, Turkish companies had $225 billion in long-term overseas loans, almost all of that in dollars or euros. Firms have been drawn to foreign-currency debt by lower interest rates, but have now been squeezed by the lira weakness.
In a statement released shortly after the central bank's announcement, Albayrak said the fight against inflation would be conducted in coordination with growth targets. However, he made no mention of its decision.
Additional reporting by Daren Butler and Ali Kucukgocmen in Istanbul, Nevzat Devranoglu in Ankara and Sujata Rao in London; Writing by David Dolan; editing by Larry King and David Stamp