Czech crown regains ground, but sentiment shaky

PRAGUE, Oct 20 (Reuters) - The Czech crown regained early losses against the euro on Friday, but expectations that the central bank will hold interest rates at the lowest level in the European Union next week were seen weighing on market sentiment.

The crown traded at 28.280 per euro <0#EURCZK=> by 1350 GMT, firming about quarter of a percent from the previous domestic close but barely changed from a high reached in after-hours trade overnight.

Only two of 24 economists in a Reuters poll predicted a 25 basis point interest rate increase when CNB policymakers gather on Oct. 26.

The rest saw the main policy rate remaining at 2.50 percent, the lowest level in the EU along with Sweden, after 25 basis point increases in July and September aimed at keeping inflation at bay as household demand steps up a gear. For a news report, double click on [ID:nL20451838].

The outlook for near-term interest rate stability, along with jitters over the deteriorating budget outlook and a five-month-old political crisis, has dampened investor interest in crown-denominated assets.

The Czech currency has underperformed central European peers so far this month, holding largely steady to the euro while the Slovak crown, Polish zloty and Hungarian forint gained some 2.2 percent, 2.7 percent, and 3.6 percent respectively.

Some analysts said rising appetite of global investors to take risks in emerging markets meant the crown was back in fashion as the so-called funding currency, as low Czech rates made it appealing to fund investment in higher-yielding units.

"You have the worsening current account and fiscal deficits, no prospect of a stable government, plus the central bank is in no rush to raise interest rates and the crown is being used as a funding currency," said Olivier Desbarres at Credit Suisse.

"All these factors lead me not to expect a strong rally in the crown that some people might be looking for," added the analyst who sees the crown weakening to 29 per euro within 12 months, the most bearish forecast in a Reuters poll <CZ/ECON07>.

CNB policymaker Jan Frait dampened expectations of another quick interest rate hike this week, telling Reuters in an interview that benign price pressures should allow the CNB to adopt a cautious approach to a further tightening of policy.

- For full news report on the interview, see [ID:nL1856741].

----------------- MARKET SNAPSHOT AT 1349 GMT ----------------- Crown/euro <EURCZK=> last deals at 28.280 (+0.28 pct) Crown/dollar <CZK=> at 22.395 bid (+0.46 pct)

5-year yield due Oct 2010 <CZ5YT=RR> 3.59 pct bid (-7 bps) 10-year yield due Jan 2016 <CZ10YT=RR> 3.83 pct bid (+2 bps)

5-yr CZK/EUR mid yield spread <DE114147=> -17 bps (vs -9) 10-yr CZK/EUR mid yield spread <DE113529=> 0 bps (vs -2)

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

((Reporting by Marek Petrus; prague.newsroom@reuters.com; Editing by Gerrard Raven; Reuters Messaging: marek.petrus.reuters.com@reuters.net; +420 224 190 477))

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Keywords: MARKETS CZECH CROWN CLOSE