Emerging FX-On back foot due local politics, inflation worries

By Sujata Rao

LONDON, Sept 28 (Reuters) - Emerging market currencies stayed on the back foot on Thursday, as Polish political squabbling weighed on central Europe and inflation concerns forced the South African rand to pare early gains.

The zloty extended losses triggered by a corruption scandal that is threatening to bring down Poland's minority government.

The ruling party has been scrambling to build a new majority coalition after ditching its partners last week in a row over the budget. But the budget itself came under fire on Thursday from central bank governor Leszek Balcerowicz.

Though the budget includes the promised deficit cap, Balcerowicz called it "careless" and said it would require further borrowing. The limited market reaction to the country's political worries may not "last for ever," he added.

"We have lingering political risks in Poland and relatively unhelpful comments from the central bank there on the budget. News elsewhere has been thin on the ground and Poland is setting the tone more than anything else," said Lucy Bethell, emerging markets strategist at the Royal Bank of Scotland in London.

By 1000 GMT the zloty fell almost half a percent to 3.98 per euro <EURPLN=>, almost a week low, while the forint eased 0.16 percent to 273.15 <EURHUF=>, its weakness having been checked -- at least for now -- by a 50 basis-point rate rise this week.

The Czech and Slovak crowns also weakened, as support provided by surprise 25-bps rate rises in both countries ebbed.

Analysts say the Polish problems and recent anti-government demonstrations in neighbouring Hungary are symptomatic of reform fatigue in the four largest new European Union members, where elections have yielded troublesome coalitions.

The World Bank said this week that eastern European countries were failing to take advantage of booming economies to enact key reforms and put their fiscal houses in order.

Bethell recommended selling zloty versus the euro at 3.9830 to target 4.10, saying chances of early elections had increased dramatically and bond markets were starting to suffer from hawkish central bank rhetoric.

Bond yields across the region have been inching higher as inflation pressures grow, forcing the surprise central bank moves this week.

RAND HIT BY PPI

The South African rand slipped off a one-week high against the dollar, after higher-than-expected producer inflation. August PPI came in at 1.5 percent compared to 1.7 percent in July but year-on-year, the 9.2 percent number was the highest since December 2002.

The currency enjoyed some support from a gold price rebound to $600 an ounce for the first time in two weeks. It pared gains from a session high of 7.55 to 7.62 per dollar, flat on the day.

"International investors are seeing any bad data as an opportunity to sell rand. The fact is the SARB (central bank) will look at the PPI as something that will feed through into CPI as well," said Madhur Jha, analyst at IDEAGlobal in London.

Jha forecast South African rates to rise at least 100 bps more this year and the rand to weaken to 7.7-8 per dollar, while higher rates are seen hitting bond markets and economic growth.

Some analysts said trade deficit numbers due on Friday could hit the rand hard if they prove weak.

"The picture emerging is not positive for the economy," Jha said. "I expect that even if the risk environment improves people will discriminate against the rand as there is no positive news ... and no pull factor to come and invest."

Investors are now waiting for 1230 GMT U.S. second quarter economic growth data and a key inflation reading on Friday that may clear the picture on the U.S. rates outlook.

Stronger-than-expected U.S. consumer confidence data and a rise in new home sales in August has boosted conviction that a soft landing is the most likely scenario for the U.S. economy.

((Reporting by Sujata Rao London Newsroom +44 20 7542 6176 sujata.rao@reuters.com; editing by Ruth Pitchford))

Keywords: MARKETS EMERGING FOREX