* Latest twist in battle over corruption investigation
* Rival dismisses accusations as "dishonourable propaganda"
* Sarigul standing as Istanbul mayor in key election
By Ayla Jean Yackley
ISTANBUL, Jan 26 (Reuters) - Turkish Prime Minister Tayyip Erdogan brandished what he said was a file of graft allegations against a senior opposition figure on Sunday, raising the stakes in a political battle after a corruption investigation implicated his own government.
Mustafa Sarigul, the main opposition's candidate for Istanbul mayor, dismissed the allegations as "dishonourable propaganda" on Twitter. He had earlier said all accusations against him had been investigated and dismissed.
Erdogan appeared on live television, holding up enlarged copies of what he described as a report prepared by Sarigul's own party that he said listed "improprieties" during the candidate's time as mayor of the middle-class borough of Sisli.
"Corruption to do with building permits occurred. Hundreds of millions of lira of improprieties were conducted," Erdogan said, referring to what he said were allegations in the report.
"At the Sisli municipality, starting with the Sisli mayor, they continually turned a blind eye and facilitated illegal building ... All of this is in this file. They cooperated with the construction mafia. In exchange for bribes, they secured extraordinary unfair profits."
Sarigul is standing in a municipal election, slated for March 30, that is seen as a test of the popularity of Erdogan's ruling AK party in the wake of the wider graft investigations and large-scale anti-government protests in June.
"Dishonourable propaganda is the game of losers. You cannot stop our big march with slander and defamation," Sarigul said on his Twitter account. "I understand the prime minister's excitement. It's the panic of losing, it has obstructed reason."
Sarigul's Republican People's Party (CHP) accused Erdogan of bullying and defied him to make public any accusations he cared to level when he first threatened to divulge the file on Friday.
Turkey's prime minister has been fending off graft charges against members of his inner circle after a police investigation came to light last month.
Erdogan has said the operation, which included the arrest of three sons of cabinet ministers and businessmen close to the government, was a "coup plot" against his AK Party, in power since 2002.
He has responded by removing thousands of police officers and about 120 prosecutors from their posts and reassigning them, and by pushing through legal changes that tighten his control over the judiciary.
Erdogan has also accused the CHP of lending moral support to those behind the graft probe.
The prime minister said the allegations against Sarigul had been made in a report prepared by the CHP in 2004.
Sarigul, 57, left the CHP in 2005 and only returned in late 2013 to run on the CHP ticket for the top Istanbul job - a post held by Erdogan in the 1990s.
Erdogan on Sunday denied having any role in the state banking regulator's decision this month to seize all of Sarigul's assets, reportedly in connection with an unpaid loan from the 1990s. He said the watchdog was acting on new information.
Erdogan also denied what he described as rumours that his wife Emine had amassed several businesses, and media reports that his son and son-in-law were involved in wrongdoing. (Additional reporting by Nicholas Tattersall; Editing by Andrew Heavens)