July 30 (Bloomberg) -- Turkish Prime Minister Recep Tayyip Erdogan survived a court challenge to force him from office, ending months of political uncertainty that threatened to derail the $660 billion economy.

Six of 11 judges on the Constitutional Court voted to close down the party, one short of the seven required, chief judge Hasim Kilic told reporters in Ankara today. Instead judges ruled that the Treasury should reduce state funding for the party as a punishment for violating a constitutional ban on basing government policy on religious edicts.

``This decision constitutes a serious warning to the Justice and Development Party,'' Kilic said. ``I hope they will take the necessary lessons.''

The decision may extend a one-month rally on Turkish markets as investors bet Erdogan would triumph in his latest battle with secularists led by the army. Opponents say his economic success, which includes bringing inflation to a 37-year low of 6.9 percent last year, masks a secret Islamic agenda designed to make Turkey more like Iran.

The lira rose to 1.168 to the dollar, a three-month high, after the decision. Turkey's stock and bond markets were closed when Kilic made the announcement.

Turkey's ``democracy and legal system emerged stronger from the ruling,'' Erdogan told reporters in Ankara tonight. The Justice party ``has never been a focal point for anti-secular activities, and it will continue to protect the basic gains of democracy,'' he said.

`Major Setback'

The verdict is ``a major setback for the secularists and will strengthen the party's hand even further,'' said Ahmet Akarli, an economist at Goldman Sachs in London. `Still the domestic political scene is likely to be prone to intermittent crises.''

Turkish stocks and bonds slumped after the trial began in March on concern that the closure of the country's most popular party since 1965 might jeopardize the political stability required to extend a record period of economic growth and progress toward membership of the European Union.

Markets have recouped most of those losses in the past month, as investors bet that Erdogan's party would escape closure. The rally continued today, as the benchmark ISE-100 stock index gained 5.6 percent, the most in six months, and yields on lira bonds fell to the lowest since May.

The decision means Erdogan and his 339 lawmakers will probably continue to rule Turkey until the next general election, due by 2012. The party has 130 seats more than the opposition combined after it won an election last year with 47 percent of the vote.

`All Sides Satisfied'

``I think this is a solution that will satisfy all sides,'' said Yarkin Cebeci, an economist at JPMorgan Chase & Co. in Istanbul. ``The party will remain in power but will see that it is not omnipotent.''

The Justice party received 47 million liras ($40 million) in Treasury aid at the start of this year, and will lose half of next year's aid as a result of the verdict.

Erdogan's victory in the trial probably won't end hostilities with his secular opponents, particularly if Erdogan presses ahead with policies designed to further strengthen Islam's influence among Turkey's 70 million people, said Wolfango Piccoli at Eurasia Group in London, which analyses political risk.

``The key risk is that Turkey may witness a similar crisis in the near future,'' Piccoli said.

Last month, the same court struck down a law relaxing curbs on the Islamic-style headscarf. In his indictment against Erdogan's party, Chief Prosecutor Abdurrahman Yalcinkaya had cited the government's attempt to implement that measure as proof that it had a ``secret agenda'' to introduce Islamic law in Turkey.

President George W. Bush is banking on political stability in Turkey, which is 99 percent Muslim, to help encourage democratic change in regional neighbors Iraq, Iran and Syria.

The government plans to press ahead with measures to secure membership of the EU, Erdogan said today.

Olli Rehn, the EU's commissioner for enlargement, responded to the court ruling by urging Turkey to ``resume with full energy its reforms to modernize the country'' and called for ``alignment of Turkey's rules on political parties with European standards.''

Erdogan has also vowed to continue with a program of state asset sales that helped bring a record $22 billion in foreign investment last year.

To contact the report for this story: Mark Bentley in Ankara at mbentley3@bloomberg.net

Last Updated: July 30, 2008 14:27 EDT