RPT-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, and gave a clear signal a further tightening was needed to confront risks stemming from a weaker crown and strong economic growth.

Six out of seven policymakers voted to raise the main two-week repo rate used to mop up excess money market liquidity to 3 percent after a quarter-point hike in May. One demanded a 50 basis point increase.

The quarter-point hike narrowed the yield discount versus the euro zone benchmark borrowing costs to 100 basis points from the previous record high but the Czech policy rate remained the lowest in the European Union .

"The voting record implies we discussed a 50 basis point rise, and relatively thoroughly," CNB Governor Zdenek Tuma told a news conference. "Our inflation forecast is consistent with a rise in interest rates over the horizon of one to two years."

In line with the CNB's long-standing policy, he declined to elaborate on the timing and size of any possible future hikes, but afterward Tuma told Reuters in stronger terms that the board was in agreement that a move had to be taken.

"We were in consensus that interest rates should rise. The only debate was about the question as to whether it (the hike) should be 25 basis point or 50 basis points," he said.

The crown rose to three-month highs around 28.045 against the euro late on Thursday, also helped by some unwinding of speculative strategies known as carry trades, which investors funded out of the cheap, low-yield Czech currency.

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 falling more than 2 percent in the year-to-date.

A weaker crown spurs price rises in the small open economy.

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 CNB's upwardly revised quarterly forecast showed inflation looked set to overshoot its 3 percent target in October and keep rising into 2008.

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

The CNB raised its inflation projection for up to 18 months ahead, saying it saw annual price growth hovering around the 4 percent upper edge of its target tolerance band through the whole of next year.

The CNB saw annual headline inflation at 3.5-4.9 percent in both June 2008 and December 2008, up from 2.7-4.1 percent predicted for end-2008 in the previous forecast from June.

But Tuma said the outlook was burdened by a great deal of uncertainty over inflation expectations, developments in main euro zone economies, the crown's exchange rate as well as the government's planned tax changes and public spending cuts.

"We are in consensus that the risks to the baseline (forecast) scenario are balanced (but) there are relatively sizeable uncertainties," he said.

Overview of updated CPI, GDP forecasts: [ID:nPRA001408]

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

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

Profiles of CNB board members: [ID:nL28883806]

-- Additional reporting by Petra Vodstrcilova