Czech crown hits 10-month lows, seen on back foot

...using the low-yield unit to fund purchases of high-yielding currencies and assets in other markets.

The crown closed domestic trading slightly weaker on the day at 28.565 per euro by 1515 GMT, touching its weakest level since July 2006 and deepening its losses since hitting lifetime peaks in late December 2006 to 4 percent.

It lost third of a percent against the U.S. dollar , a reflection of the dollar's gains versus some major currencies.

The crown's slide was out of step with a recovery in central European markets. Higher-yielding Hungarian forint and Polish zloty gained in afternoon trade on a rise in U.S. Treasuries, which are indicative of global risk appetite.

Ceska Sporitelna analyst Lubos Mokras said a sustained break through the 28.50 crown support versus the euro, confirmed on a market close above that level, could now open the scope for further losses towards next support levels at 28.65 and 28.85.

The crown has become one of the world's most popular funding currencies, along with the Japanese yen and the Swiss franc, for a strategy known as "carry trade," in which investors sell a low-yielding currency for higher-yielding assets with the goal of capturing the interest rate spread.

"The long-term firming trend (in the crown) has ground to a halt mainly because of a significantly negative interest rate differential," said Jan Vejmelek, analyst at Komercni Banka.

The record 125 basis point gap between the Czech Republic's 2.75 percent policy rates and higher euro zone equivalents has dampened the crown's allure despite robust fundamentals and much faster economic growth than in Europe's single currency area.

Views of central bank policymakers have been split over whether the outlook for robust consumer-led economic growth to continue and inflation to top 3 percent this year warrants an urgent credit tightening after 25 basis point hike in May.

Many investors bet the crown's weakness raised the chances of another quarter-point rate hike to a near 5-year high of 3.0 percent as early as July to tame inflation nearing a 3 percent goal and strongest growth in household spending in 3 years.

----------------- MARKET SNAPSHOT AT 1525 GMT ----------------- Crown/euro last deals at 28.555 (-0.14 pct)

Crown/dollar at 21.464 bid (-0.32 pct)

5-year yield due Oct 2010 3.95 pct bid 10-year yield due Jan 2016 4.36 pct bid

5-yr CZK/EUR mid yield spread -65 bps 10-yr CZK/EUR mid yield spread -29 bps

Current levels versus prior domestic close at 1500 GMT ---------------------------------------------------------------