UPDATE 3-Czechs raise rates to 5-year high to tame inflation

...

By Marek Petrus

The Czech central bank (CNB) raised key interest rates by a quarter of a percentage point on Thursday to their highest level in five years, and stuck to the outlook for tighter policy to curb resurgent inflation.

CNB policymakers increased the key two-week repo rate to 3.25 percent after a tight vote, showing more concern about an upturn in inflation than the possibility of damage to the economy from turbulence in global financial markets.

Four members of the seven-strong policy board voted for the rate rise, the second in as many months. The remaining three wanted no change.

"Our view of the Czech economy has not fundamentally changed ... Our forecast (unveiled in July) remains in place, and this forecast is consistent with a rise in interest rates," CNB Governor Zdenek Tuma told a news conference.

"I have to admit that it is not quite clear to me what we shall be waiting for (in tightening policy further)," he added.

Many people in the markets had not expected the CNB to deliver this year's third rate rise as early as this month, and the crown firmed slightly while debt yields and money market rates rose across the board on the news.

Nine out of 16 CNB watchers surveyed by Reuters last week had forecast no rate change on Thursday, while the remaining seven predicted a quarter-point rise [CNB/INT].

The split partly reflected waning expectations of a quarter percentage-point rate rise to 4.25 percent by the European Central Bank when it decides rates on Sept. 6 [ECB/INT].

Concerns about weaker growth in the world economy after a credit squeeze combined with soft domestic data to sap investor convictions that that another Czech rate rise was imminent.

"We had expected the central bank would wait for a cooling down of the situation on global markets," said David Navratil, economist at Ceska Sporitelna. "The central bank is focusing on a local view of the economy rather than a global view."

INFLATION ON RISE

The CNB's sixth quarter-point rate rise since credit costs bottomed out at an all-time low of 1.75 percent in October 2005 follows a similar step by neighbouring Poland on Wednesday and a quarter point Czech increase in July.

The main Czech rate remains the lowest in the European Union but its discount to the higher euro zone equivalent has narrowed to three quarters of a percentage point.

Tuma's comments re-iterated the bias for tighter policy to counter a projected rise in inflation above the 4 percent upper limit of the bank's comfort zone next year, spurred by 6 percent economic growth, tax increases and higher regulated prices.

Annual inflation was 2.3 percent in July but the CNB staff projection sees a quick pick-up to above the 3 percent target later this year. The CNB aims to keep inflation within 1 percentage point either side of the target.

"The main argument (for higher rates) is the inflation outlook pointing at a sharp rise in inflation in 2008," said Jan Vejmelek, economist at Komercni Banka. "We expect yet another rate increase during the fourth quarter of 2007."

The crown erased all of its early losses to firm to 27.615 per euro by 1406 GMT from 27.685 before the rate announcement, firmer from levels around 28.00-28.20 on which the CNB's staff has based its inflation projections.

[PRAGUE/Reuters/Finance.cz]