UPDATE 2-Czechs raise rates to 5-year high, more hikes seen

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By Marek Petrus

PRAGUE, July 26 (Reuters) - The Czech central bank (CNB) raised interest rates to a near five-year high on Thursday, matching market expectations that tighter policy was needed to confront risks stemming from a weaker crown and strong growth.

Policymakers raised the main two-week repo rate used to mop up excess money market liquidity to 3 percent after a quarter-point hike in May. Despite the move, the Czech policy rate remained the lowest in the European Union .

CNB Governor Zdenek Tuma will hold a news conference at 3:30 p.m. (1330 GMT) to elaborate on the decision which narrows the yield discount versus the euro zone benchmark borrowing costs to 100 basis points from the previous record high.

"Our bias is that nobody in the CNB Board objected to the hike and a counter-proposal for a 50 basis point hike could even have emerged," said Pavel Sobisek, analyst at UniCredit.

The crown ticked up to a near three-month high of 28.110 against the euro after the rate announcement but later clawed its way back to hold largely flat on the day around 28.130 by 1115 GMT. Money market rates gained slightly.

Financial markets are gearing up for further interest rate increases in the coming months after consumers helped to propel the central European economy in early 2007 to the eighth consecutive quarter of annual growth exceeding six percent.

Investors have fully priced in a rate rise to 3.25 percent by October, according to Reuters data.

"I am forecasting 100 basis points more in rate hikes from here," said Istvan Zsoldos, economist at Goldman Sachs. "They appear to be going at a quarter by quarter speed."

INFLATION SEEN ABOVE TARGET

The yield disadvantage, dampening the crown's allure to foreign investors, has led to the domestic currency shedding more than 2 percent in the year-to-date.

A weaker crown spurs price rises in the small open economy. Inflation looks set to overshoot the CNB's target of 3 percent before the year-end.

Consumer inflation has quickened to within the tolerance range of one percentage point either side of the CNB's 3 percent goal, running at 2.5 percent year-on-year in June .

The inflation pick-up has mainly reflected higher cigarette taxes and a rise in electricity and other government-regulated prices, with policymakers' preferred gauge excluding the primary effects of tax changes staying quite low.

But analysts, and some central bankers, have cautioned against a further blossoming of underlying price pressures stemming from buoyant consumer demand and signs of labour shortages in the car-making and other industries.

"Bankers reacted mainly to this year's three phenomena: The fastest household consumption in three years, the highest wage growth in five years and a weak crown against the euro," said Ales Michl, analyst at Raiffeisenbank.

At the news conference, the CNB was widely expected to unveil an upwardly revised inflation projection, possibly raising the prospect of price growth attacking the upper edge of its target tolerance band later this year or early next year.

In June, inflation was already half a percentage point above the CNB's previous forecast from April which saw annual growth in consumer prices at 3.2-4.2 percent at end-2007 and 2.7-4.1 percent at end-2008.

INSTANT VIEW of analysts' comments: [ID:nL26757301]

Board members' recent remarks on policy: [ID:nL26743022]

Profiles of CNB board members: [ID:nL28883806]