UPDATE 2-Czech c.bank surprises with 1/4 point rate rise

(Adds quotes, updates market reaction, background)

By Jan Lopatka

PRAGUE, Sept 27 (Reuters) - The Czech central bank raised its key interest rate by a quarter percentage point on Wednesday, wrong-footing many analysts who had largely expected policymakers to hold off tightening until next month.

The decision, however, was not a complete surprise after unexpected tightening moves this week by fellow central European banks in Hungary and Slovakia, and amid a worsening Czech fiscal outlook, growing household demand and a weaker crown currency.

The Czech decision puts the 2-week repo rate at 2.50 percent, 50 basis points below the key euro zone rate. Czech rates remain the lowest in the European Union, alongside Sweden.

"The main reason is a speeding up of domestic demand, a weaker crown in recent days, the development of public finances and an increase in rates in the euro zone and in neighbouring countries," said Patrik Rozumbersky, an analyst at Zivnostenska Banka, on the Czech decision.

"I think there will now be a halt in the tightening cycle to the end of the year. The next hike will be at the beginning of next year," he said.

In Poland, the central bank left rates steady as expected on Wednesday. But this week Slovakia has surprised markets by raising rates a quarter percentage point while Hungary delivered a half percentage point increase, when slim majorities of analysts and traders had predicted only a quarter point rise.

The Czech National Bank made no comment on its decision but called a news conference for 3.30 p.m. (1330 GMT).

The crown currency, which is key for inflation development in the small open economy, firmed to 28.400 to the euro <EURCZK=> at 1035 GMT from 28.425 just before the decision.

Last month, the central bank's board voted unanimously to hold rates steady and said it saw balanced risks to its July quarterly inflation forecast, which saw gradual rate hikes and inflation at 3.3-4.7 percent at end-2007, above the bank's 3 percent target.

It also said crown strength was the sole major downside risk to inflation. The currency has, however, dropped from a record high of 27.955 seen earlier in August due to dividend payments abroad and a weakening export momentum.

Several central bankers have harshly criticised an expected widening of the fiscal deficit next year, coming at a time of record 6 percent economic growth.

"I believe the decision is wise given the deteriorating fiscal outlook and development of the crown," said Radomir Jac, chief analyst at PPF, adding that he saw some possible moderate firming of the crown as a result, but no marked reaction.

"I think we received a very clear signal from the central bank over the past two weeks that a rate hike may come as early as in September and the yield curve has fully priced in a 25 basis point move for the board meeting," he added.

The government has approved a 2007 state budget consistent with a public sector deficit at 4.0 percent of gross domestic product, far above the 3.3 percent cap in its euro convergence programme and almost certainly ruling out adoption of the common currency as planned in 2010.

The jump comes mainly due to benefit handouts by politicians before elections in June. The polls ended in a stalemate, producing a weak minority cabinet which has little clout to push through reforms and is likely lose a confidence vote next week.

Most analysts expect the deadlock will lead to months more of political uncertainty and an early election next year. ((Reporting by Jan Lopatka, editing by David Stamp; prague.newsroom@reuters.com; Reuters Messaging: jan.lopatka.reuters.com@reuters.net; +420-224 190 474))

Keywords: ECONOMY CZECH RATES