UPDATE 2-Czech central bank holds rates as its forecasts signal hike

(Adds governor comments, market reaction, details)

PRAGUE, Nov 7 (Reuters) - A divided Czech National Bank (CNB) held interest rates on Thursday, with the knock-on effect of economic weakness abroad staying its hand as new economic forecasts issued by the bank pointed to two hikes by next March.

Central European growth has held up this year thanks to strong domestic demand even as many major developed economies, including Czech Republic’s biggest trade partner Germany, face slowdowns and their central banks ease policy to support them.

The Czechs are among the few in Europe still debating whether tighter policy is needed to rein in inflation, which has run at or above the 2% midpoint of the central bank’s target range since May 2018.

The board, in a longer-than-usual debate, voted 5-2 to leave the main two-week repo rate at 2.00%, keeping the Czech rate at its highest spread over its euro zone equivalent since 2000.

The two dissenters wanted a 25 basis point increase, same as at the last meeting in September, arguing that domestic price pressures from record-high employment and wage growth outweighed fears of contagion from a slowdown abroad.

Thursday’s debate was based on the bank’s new quarterly economic outlook, which cut its 2020 growth forecast to 2.4%, and saw inflation higher and the crown currency weaker than previously expected.

It also assumed two 25-point interest rate increases, one this quarter and one in the first three months of 2020.

“This contradictory (foreign and domestic) situation means the board has to weigh the delicate differences whether to lean toward the recommendation of the forecast or not,” Bank Governor Jiri Rusnok said.

He said the main argument for unchanged rates was the slowdown abroad, and some Czech companies were already seeing a drop in orders and capacity cuts.

The outlook’s recommendation for rate hikes was based on the perceived need to quell domestic inflationary pressures, with a drop in rates following from the middle of next year.

The central bank has one more policy meeting this year, and Rusnok said not following the forecast’s implications would not raise inflation by more than 0.2 percentage points compared with the forecast path.

All 14 analysts in a Reuters poll had expected no change and a majority saw that continuing throughout 2020. The five who expected a change next year forecast the start of an easing cycle, while analysts who expected more rate hikes do not see that reversed until 2021 or later.

The crown eased, trading down 0.1% to the euro at 1452 GMT. Interest rate markets headed up as much as 12 basis points.

Forward rate agreements had started to price out chances of a rate cut in the next year in recent weeks.

Reporting by Jan Lopatka and Robert Muller, editing by Jason Hovet and John Stonestreet