(Adds renewed expectations of rate cut, background)
By Behiye Selin Taner and Ali Kucukgocmen
ISTANBUL, Oct 18 (Reuters) - Turkey's lira firmed nearly 1% against the dollar on Friday, as the prospect of severe sanctions from the United States waned after Ankara agreed to a ceasefire in northern Syria, raising expectations of a rate cut by the central bank next week.
The currency had been under pressure due to a deterioration of ties between Ankara and Washington over Turkey's operation against the Kurdish YPG militia, which was a main U.S. ally in the fight against Islamic State.
In meetings between the allies on Thursday, Ankara agreed to a ceasefire for five days while the YPG withdraws from Syrian border regions. U.S. Vice President Mike Pence said sanctions would be removed after the deal is implemented and no further sanctions would be pursued.
The lira stood at 5.7805 against the dollar at 1238 GMT, firming some 0.75% from Thursday's close of 5.8250. It firmed to 5.7580 earlier.
It had weakened to 5.9395 this week in anticipation of the sanctions, which turned out to be softer than expected.
Jason Tuvey, senior emerging markets economist at Capital Economics, said while further sanctions were off the table for the moment, things could still go wrong with implementation of the ceasefire.
"After the five days, there could be an escalation of conflict in northern Syria," he said, adding that this could lead to another strain with Washington and bring sanctions back into play.
U.S. prosecutors this week charged Turkey's Halkbank with evading sanctions on Iran, a move which Turkey said was also related to its operation in Syria. Pence said he told Turkish officials that the case was a matter for the New York court that charged the bank.
Halkbank shares, which had plummeted following the news earlier this week, surged at Friday's opening, rising some 7.16%. They were up 6.21% at 1221 GMT.
The main BIST100 share index was up 3.82%, while the banking index was up 5.93%.
Despite the ceasefire agreement, Republican Senator Lindsey Graham and Democratic Senator Chris Van Hollen will move "full steam ahead" with plans to impose stiff sanctions on Turkey.
House Speaker Nancy Pelosi said the House of Representatives would vote on a bipartisan sanctions package against Turkey next week.
Trump may try to veto or delay implementation of those sanctions, despite strong bipartisan support, Tuvey said, adding: "He seems to be taking a fairly soft line on sanctions against Turkey."
After the agreement between the allies eased pressure on the lira, expectations the central bank will cut interest rates at next week's meeting have risen again.
QNB Finansbank chief economist Erkin Isik said the recent volatility in the lira had lowered rate cut expectations.
"Considering the agreement reached about Syria and the appreciation of the lira, we expect a 100 basis point cut from the monetary policy committee next week," he said, citing improvements in inflation.
The central bank has already cut its policy rate by 750 basis points this year, after hiking it to 24% last year to halt a currency crisis. Governor Murat Uysal has said the rate cuts were front-loaded.
Inflation, which hit a 15-year high of more than 25% in October last year, declined to below 10% last month.
Ata Invest Director Cem Tozge said the bank could cut borrowing costs by between 100 and 200 basis points.
"When we look at both the swap pricings and the lira LIBOR pricings, we see that a 200 basis point cut in the next three months, starting with 100 basis points next week, is being priced in," he said.
Turkey's five-year credit default swaps, a gauge of the cost of insuring exposure to its sovereign debt, fell to 371 basis points on Friday, down from 385 basis points at Thursday's close, according to IHS Markit data.
Longer-dated government bonds chalked up gains, with the 2030 issue jumping 1.6 cents to 135.186 cents in the dollar, according to Tradeweb.
Dollar-denominated bonds issued by Turkey's second-largest bank Halkbank also gained, with the 2021 issue adding as much as 2.7 cents to 89.95 cents in the dollar. (Reporting by Ali Kucukgocmen and Behiye Selin Taner; Additional reporting by Tom Arnold in London; Editing by Daren Butler and Catherine Evans)