* Widening output gaps expected to undercut inflation
* Hungary, Romania seen cutting interest rates
* Poland, Czechs seen keeping rates on hold for some time
* Polish mkts pricing in rate hikes
By Michael Winfrey and Karolina Slowikowska
PRAGUE/WARSAW, Oct 16 (Reuters) - Slowing inflation, rising
joblessness and growing output gaps are likely to hold interest
rates lower than earlier expected across Central Europe and
shore up expectations for further cuts in its weaker economies.
Economists expect Hungary's central bank to cut its interest
rates by 50 basis points on Monday to 7 percent and to bottom
out at 5.5 percent by next year. Romania is also seen cutting
half a point to 7.5 percent at a meeting in November.
And, with all eyes on the glacial pace of the economic
recovery, some market watchers say earlier expectations of
possible rate hikes in the first half of 2010 in Poland and the
Czech Republic may not be justified.
At the crux of the issue is when western demand for the
cars, electronics and other cheap goods that drove growth across
the EU's ex-communist east in the boom times will resume.
Until it does, unemployment will rise, wages will stagnate,
and factories will remain idle, meaning countries will
experience output gaps, in which they operate below their
capacity.
That has eroded household spending and investment by firms,
which in turn has undercut inflation and raised the prospect of
lower, or at least stable, rates for several quarters.
"It was only two or three months ago that people were
talking about rate hikes in the first half of next year," said
Neil Shearing, EMEA economist at Capital Economics.
"Now, if there's any move in the near term, it will be down,
but the bigger point is that rates will stay low for much longer
than the markets expect."
UNDER CAPACITY
Like the rest of the world's industrialised economies, those
in the European Union's eastern wing are all expected to chug
along at below capacity next year.
According to data from the industrialised states club OECD,
Hungary's output gap widened by almost half to 11 percent below
its estimated potential from next year -- the largest of OECD
members. The Czechs' is seen growing to 6.6 percent.
Poland, the only country in the European Union to avoid a
recession during the crisis, will have the most narrow output
gap of OECD states in 2010. But, at only 3.8 percent of GDP, it
is still worse than the 0.6 percent expected this year.
That is expected to push down wage growth and, combined with
rising joblessness, keep inflation down.
In September, Czech inflation hit a six-year low of zero and
the central bank, which will release a new inflation report next
month, has said prices will fall in annual terms in October.
A Reuters poll last week showed analysts expect the central
bank to keep rates on hold at an all time low of 1.25 percent at
its Nov. 5 meeting.
But the number of analysts betting on a cut rose to five of
17, and many who forecast stable rates said it would be a very
close call between that and a cut. They had been unanimous on
rates staying flat in the previous survey.
In Poland, September inflation slowed for the first time
since June to 3.4 percent and some analysts say it will fall to
around 2 percent next year, below the central bank's 2.5 percent
target.
In the latest Reuters poll of analysts, all 27 polled
expected the central bank to keep rates unchanged at least until
the first half of next year at a record low 3.5 percent.
Reuters polling of analysts shows rate rises as early as
March, and market forward interest rates price in 75 basis
points in tightening over the next 12 months <PLNFRA>. Many
analysts, though, say tightening may not come until late 2010.
Consumption is also set to be affected by the so-called
crowding out effect, when banks prefer to spend their cash on
buying safer government bonds rather than financing consumer and
business lending.
"A low inflation outlook and sluggish growth suggest that
there is no need to tighten monetary policy soon," said Michal
Dybula, an analyst at BNP Paribas.
CURRENCIES
Hungarian policymakers make no secret of the fact that rates
will keep coming down. Hungarian central banker Csaby Csaki told
Reuters on Thursday that surprise low September inflation and
strength of the forint currency had opened the way to rate cuts.
"I think this means that these create room for further
interest rate cuts," he said.
The Czechs are also facing currency strength and the central
bank shocked markets last month when Governor Zdenek Tuma said
the board had discussed a rate cut and that the strong crown
could push inflation below zero for a protracted period.
Tuma and his deputy Miroslav Singer then knocked the crown
more than 2 percent lower against the euro with a series of
verbal interventions.
Analysts expect the unit to stay above 26 per euro for some
time now, but they said the bank may have to ease rates again.
"The verbal intervention can hold the fort for a few months
but the financial account shows strong inflows and there is a
case for appreciation," said Raffaella Tenconi, Chief Economist
at Wood & Co.
"So if they want to stop appreciation, they have to reduce
the cost of capital -- i.e. cut rates."
(Editing by Patrick Graham)
