UPDATE 1-Czech cbank warns against too much growth optimism

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By Marek Petrus

PRAGUE, June 12 (Reuters) - Excessive optimism about future growth in the Czech economy may undermine financial stability if workers demand more pay and consumers exploit low credit costs to take on more debt, the central bank (CNB) warned on Tuesday.

The Czech Republic has the lowest interest rates in the European Union, which it joined in 2004, in spite of a quarter of a percentage point interest rate rise to 2.75 percent in May to tame price pressures stemming from fast economic growth.

In its annual financial stability review, the CNB concluded that the current trends in the financial sector and the economy at large -- both dominated by foreign investors -- boded well for maintaining financial stability further down the road.

However, it warned that economic growth of 6.4-6.5 percent annually in the past two years and expectations of sustained robust growth this year and next could make consumers and businesses too complacent when borrowing and investing.

"Fast GDP growth is being transformed into expectations which may become excessively optimistic ... and get reflected in wage demands, a rise in consumption financed by further loan growth and in the property market," said Jan Frait, who led the team authoring the report the 100-page report.

The CNB said loose fiscal policy, with the government seen running a deficit of 4 percent of gross domestic product (GDP) and rises in property and other asset prices could contribute to the spending boom and fuel loan growth.

Markets are betting the CNB may raise benchmark credit costs by another quarter-point to a near 5-year high of 3.0 percent as early as July, as inflation nears a 3 percent goal and household spending surges at the fastest rate in more than 3 years.

BOARD SPLIT

Views of policymakers on the seven-member CNB board have been split over whether the outlook for consumer-led growth to continue and inflation to top 3 percent this year warrants an urgent credit tightening.

Dovish board member Robert Holman told Reuters at the sidelines of a seminar presenting the report that he saw no significant inflation risks after the May rate hike.

He said the inflexible and tightening labour market was probably the biggest, although not overly troubling, source of potential inflationary pressures after a fall in unemployment to long-term lows around 6.5 percent.

In contrast, board member Vladimir Tomsik was quoted as telling Bloomberg that rates were "quite low" in light of fast growth and he "can't rule out" rate increases to combat "accumulating pro-inflationary risks."

The CNB also said renewed pressure for "excessive appreciation" in the crown cannot be ruled out, as yield-hungry investors keep piling into riskier emerging markets assets.

Holman said healthy economic fundamentals would at some point help the crown overcome its yield disadvantage against major currencies and resume its long-term appreciation trend.

Selling by foreign investors has sent the crown to more than 3 month lows around 28.470 per euro by Tuesday, nearly 4 percent below lifetime peaks reached last year when its rise helped contain inflation and led the CNB to delay rate hikes.

HIGHLIGHTS OF THE REPORT........................[ID:nL12446528]