UPDATE 1-Czech Sept shop prices fall, rate hike bets tamed

(Writes through with further analyst quotes, background)

By Marek Petrus

PRAGUE, Oct 9 (Reuters) - Czech consumer prices posted a sharper than expected drop in September from August, easing pressure on the central bank (CNB) to keep tightening policy quickly to contain demand in the booming economy.

Data published on Monday showed the consumer price index (CPI), an inflation gauge targeted by the central bank, fell 0.7 percent month-on-month, mainly because of a seasonal 18.2 percent drop in holiday prices and lower fuel and food prices.

The fall exceeded the market consensus forecast of a 0.5 percent drop and squeezed the annual inflation rate to 2.7 percent, below the 3 percent midpoint of the CNB target.

"This number could tame expectations of a fast interest rate increase," said David Marek, chief analyst at Patria Finance.

Even before the data, the central bank had been expected to pause in credit tightening in October, following two quarter percentage-point rate increases in July and September responding to a projected demand-led pickup in inflation.

The Czech economy has grown at a 6 percent annual clip, with a growing contribution from consumer spending which policymakers worry could stoke inflation pressure already heightened by this year's rise in oil costs.

Inflation concerns have also risen because of a relaxed fiscal policy, and a further budget worsening seen next year due to an increase in welfare spending approved before a June election.

Price growth is forecast to stay contained and ease towards 2.5 percent in the coming months, before returning above the 3 percent level next year.

"Low CPI in the fourth quarter will lower pressure for higher Czech rates," said Citibank economist Miroslav Plojhar.

The CNB has predicted 4 percent inflation at end-2007, assuming that there is a further gradual rise in interest rates. It is expected to issue a comment on the data later in the day.

RETURN TO 'NEUTRAL'?

The Czech Republic has the lowest level of interest rates in the European Union along with Sweden, with the key policy rate at 2.50 percent, a record 75 basis point discount to the European Central Bank's benchmark rate.

Financial markets have bet on another quarter point hike before the year-end. Analysts said Monday's data did little to change expectations of further tightening, mirroring the trend towards higher borrowing costs seen across central Europe.

"There is no reason to alter the outlook for ... long-term growth (in interest rates) and a return to neutral levels," said Jan Vejmelek, head of economics research at Komercni Banka.

Economists mostly say a neutral interest rate level -- one that neither spurs inflation nor curbs growth -- would lie below but close to 4 percent.

CNB policymaker Jan Frait on Monday reinforced expectations that the CNB would continue unwinding accommodative policy adopted in recent years to stem a rise in the crown currency.

Frait told a weekly newspaper in an interview the state of the global economy now called for higher Czech interest rates.

The crown stagnated around 28.200 per euro <EURCZK=>. Government debt yields were mixed and little changed on the day. ((Editing by David Stamp; 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; editing by Ruth Pitchford))

Keywords: ECONOMY CZECH INFLATION