UPDATE 2-Czechs drop 2010 euro target-finance min source

(Recasts with finmin source, analyst quotes, background)

By Marek Petrus

PRAGUE, Oct 25 (Reuters) - The Czech Republic has dropped its aim of adopting the euro in 2010 because it is no longer realistic and plans to set no new target date, a finance ministry source told Reuters on Wednesday.

A euro convergence analysis prepared by the finance ministry and the central bank recommended the government hold off on trying to peg the crown to the euro within the ERM-2 mechanism in 2007, the official said on condition of anonymity.

Euro hopefuls must keep their currencies fixed within the ERM-2 band for two years prior to euro adoption.

"There is not even an indication of a new target date," said the official familiar with the analysis which was submitted for Wednesday's cabinet meeting. Cabinet meets at 7:30 p.m. (1730 GMT), with a news conference scheduled for 9:30 p.m. (1930 GMT).

Currency and debt markets shrugged off the news, with the crown holding nearly five percent firmer in the year-to-date at 28.360 per euro <EURCZK=>.

A euro entry delay would match growing market expectations that a deepening budget deficit will prevent the country from meeting the entry criteria until at least 2012-2013, despite the unpredecented economic expansion at a 6 percent annual rate.

"Fundamentals have been good. But, political -- and consequently fiscal -- dynamics for early euro adoption have deteriorated recently," said Radoslaw Bodys, central Europe economist at Merrill Lynch in London.

Fading political will to hold the purse strings and slash budget gaps below the euro entry limit of 3 percent of gross domestic product (GDP) has also cast doubt on the euro entry timetables of central European peers, Poland and Hungary.

LOWER CPI TARGET

Burgeoning welfare spending is forecast to boost the fiscal gap to 4.2 percent of GDP in 2007, but the protracted parliamentary deadlock following a June election has put any fiscal reforms off the political agenda.

A new euro zone entry target is unlikely to be considered before an agreement is reached on a fiscal reform programme.

The business daily newspaper Hospodarske Noviny reported on Wednesday the central bank might also have to cut its inflation target in the future to meet the euro entry goal on inflation.

The central bank (CNB) has targeted headline inflation which it seeks to keep at 3 percent year-on-year, allowing for fluctuations by plus/minus one percentage point from this level.

Some policymakers have suggested earlier the goal may permit an overshooting of the euro zone entry threshold, set at 1.5 percentage points above the average of the three EU countries with lowest inflation figures.

"That would also be negative for the bond market - not only due to the deterioration of convergence prospects, but also because ... a downward revision to the CNB inflation target ... may require tighter monetary policy," said Bodys at Merrill.

Czech 5-year/5-year forward rates <BNPPCZK> -- a key gauge of a country's euro adoption prospects -- have hovered a touch below the euro zone benchmarks, indicating investors have been betting on full debt yield convergence by 2011.

((Editing by Gerrard Raven; Reuters Messaging: rm://marek.petrus.reuters.com@reuters.net; e-mail: prague.newsroom@reuters.com or marek.petrus@reuters.com; Tel: +420 224 190 477))

Keywords: ECONOMY CZECH EURO