RPT-INTERVIEW-Czech c.bank's Rezabek eyes July rate hike

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By Marek Petrus

PRAGUE, July 17 (Reuters) - The Czech central bank (CNB) could raise the European Union's lowest interest rates by 25 basis points this month to keep inflation at bay, a central bank policymaker said on Tuesday.

Pavel Rezabek, one of the seven members of the CNB policy board, told Reuters a record-high yield discount versus the world's major currencies was making the crown vulnerable and warranted a timely rate rise.

However, he spoke in an interview against embarking on any "aggressive" tightening cycle following May's hike -- the first in 8 months -- which brought the main policy rate to 2.75 percent , running counter to suggestions made by some of the more hawkish board members.

"We will see how the (new inflation) forecast looks, but it is possible that the principle of caution wins the day and (the board) accepts an increase by 25 basis points," Rezabek said.

Markets took the unusually candid comments by one of the most dovish rate-setters as making a hike to 3 percent -- the highest rate for nearly five years -- a done deal at the board's meeting on July 26.

The crown, a popular source of cheap funds for investors, recouped early losses and rose as high as 28.247 per euro on Rezabek's remarks from 28.280 just before [CZK/].

"Consistently strong data supports an immediate rate hike, with another 25 basis points likely before the end of the year," said Lauren Van Biljon, an analyst at 4cast consultancy in London.

Policymakers will review an update of the staff inflation projections for up to 18 months ahead at the meeting next week, following data suggesting the economy's expansion remained strong after topping 6 percent annually over the past two years.

"A number of inflation risks have built up. They are not overly significant but there is a greater number of them, and it is probably ill-founded to wait any longer whether they are being confirmed," said Rezabek.

Annual inflation ran at 2.5 percent in June, half a percentage point above the forecast from April, which saw price growth creeping up to 3.2-4.2 percent at the end of this year.

Rezabek, who joined the CNB in early 2005, said he would view what he expected to be an upward revision of the inflation forecast with scepticism, as its acceptance and speedy policy tightening could again lead to the inflation target being undershot.

INFLATION BOGEYMAN

Rezabek said the CNB needed to guard against a rise in inflation as unemployment sagged to a long-term low of 6.3 percent in June and companies were having difficulty hiring workers to keep pace with booming demand.

"At the same time, labour productivity is rapidly growing ... there may be a (policy) reaction but it should not be very aggressive," he said.

He cited charts showing that between 2002 and 2006, average inflation undershot the bottom of the CNB's target tolerance band, which is 1 percentage point either side of the 3 percent goal. It remained in the lower half of the target's error margin in 2004 and 2006.

"Many times in the past I have seen the 'bogeyman' of high inflation, which did not come up to expectations. Therefore I will take a very cautious approach (to the forecast implying a rise in interest rates)," he said.

However, he voiced concern over the wide interest rate discount, despite the crown's 1 percent rally against the euro over the past week which helped cut its year-to-date losses to 3 percent.

Czech rates are the third lowest among developed economies after Japan and Switzerland, which has turned the crown into a popular source of funds for investors looking to profit from higher yields -- or carry -- in other markets.

Rezabek said the yield gap might have reached a "critical point" at a record 125 basis points versus the euro zone, dampening the appeal of the crown to investors. It has been the biggest loser among central European currencies this year.

"Our task is not to let the crown swing too much, because that could lead to big fluctuations in inflation," he said.

He was also concerned the central bank could help spark a self-fulfilling inflation revival if it flagged a steep increase in inflation and thereby spurred workers' wage demands.