* Swiss core inflation dips 0.1 pct y/y
* October CPI up 0.2 pct y/y vs forecast of +0.3 pct y/y
* Analysts see rates on hold well into 2011
(Adds analyst comment, franc, background)
By Catherine Bosley and Sven Egenter
ZURICH, Nov 4 (Reuters) - Swiss core inflation turned negative in October for the first time in at least 16 years as the strong franc dampened price pressures, indicating that interest rates could stay at ultra-low levels well into 2011.
Despite the possibility of overall falling prices, analysts see no significant risk of a harmful deflationary spiral as the economy has recovered well from last year's recession and consumers are keeping spending up as unemployment numbers fall.
The core inflation index, which excludes foodstuffs, drinks, tobacco, seasonal products and fuel, dipped 0.1 percent in October from a year earlier, the Federal Statistics Office said on Thursday. That was the first fall since at least May 1994, the earliest set of data available on the Swiss National Bank's (SNB) website.
Overall, consumer prices rose 0.2 percent from a year ago, lagging forecasts for a 0.3 percent rise. ECONCH
"The central bank has warned that overall inflation could turn negative early next year, which, if confirmed, wipes the possibility of a Q1 rate hike off the agenda with Q2/Q3 coming into focus next," said Nikola Stephan of Informa Global Markets.
At its most recent policy review in September, the SNB signalled it was in no hurry to raise its target for the three-month Swiss franc LIBOR from 0.25 percent currently.
Markets are pricing in a high probability of a first rate increase in September 2011. <0#FES:>
The SNB slashed its inflation forecast for 2011 to just 0.3 percent and the forecast for 2012 to a mere 1.2 percent and said it could not rule out overall prices falling again on a year-on-year basis at the beginning of next year. [ID:nLDE68D1IK]
But economists said the risks of a serious deflationary spiral -- falling prices, held-back consumer demand and rising unemployment -- were very low.
"The weakness in core inflation reflects the strong franc and temporary lagged effects of the recent recession," said Citigroup analyst Michael Saunders.
"However, ... real GDP growth is strong, probably above 3 percent year-on-year in 2010 as a whole," he added.
Despite the brisk economic recovery and ultra-low interest rates, inflation pressures are set to remain very low.
"Core inflation in Switzerland should remain extremely subdued for the remainder of this year and through most of 2011," BNP Paribas economist Eoin O'Callaghan said.
Switzerland has recorded lower inflation rates over the past couple of years as the country has eased trade barriers with the European Union and the entry of German discount chains to Switzerland forced Swiss retailers to slash prices.
Politicians have also called on retailers to pass on savings on imports due to the Swiss franc's strength to consumers. The country's second-largest retail chain Coop has already run an ad campaign pledging to cut prices because of the franc's strength.
The SNB forecasts the Swiss economy will expand by around 2.5 percent this year, but sees a marked slowdown in growth ahead due to the strong franc and a cooling of the global economy.
The franc rose more than 10 percent against the euro in the first six months of the year and hit an all-time peak of 1.2763 per euro on Sept. 8, though it has lost some ground since as markets have become less risk averse. The SNB had pumped some 200 billion francs into markets via intervention since March 2009 to fight the deflation risks brought by a stronger franc.
But in June this year it dropped its pledge to step in, saying that deflation risks had largely dissipated and SNB board member Jean-Pierre Danthine said recently that the current inflation forecast would not justify further interventions.
(Editing by Susan Fenton)