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CEE MARKETS-Stocks up, Polish, Hungarian bonds track Italian yield fall

* Assets mixed, Italian politics improves sentiment * Czech bonds underperform, weak crown may prompt rate hike * Main regional currencies stay near multi-month lows * Slovenian shares test 8-year high ahead of Sunday's election (Adds Slovenian election, updated prices PMI indices) By Sandor Peto BUDAPEST, June 1 (Reuters) - Central European stocks firmed and Hungarian and Polish government bond yields fell, with their curves flattening, on Friday after Italy's borrowing costs dropped sharply as it formed a new government.

Slovenian shares tested 8-year highs ahead of snap elections on Sunday.

The new Italian government of anti-establishment parties could challenge European Union fiscal rules, putting a limit on the bond recovery, but its formation ends some of the political uncertainty.

A no-confidence vote in Spain that brought in a new, Socialist-led government added to political ructions in the EU but did not upset bond markets, traders said.

"We see a bull flattening in the yield curves of both Poland and Hungary," one Budapest-based fixed income trader said. "The current (government bond) yield levels still express the view that we are still a little bit afraid." Hungarian yields dropped by 1 to 3 basis points, with the 10-year paper trading at 3.13 percent. Polish yields fell by 1 to 6 basis points and the 10-year yields was at 3.22 percent.

Euro zone member Slovenia's yields, one of the lowest in the region, rose 1-2 basis points. Ljubljana's stock index rose almost one percent, approaching an 8-year high, ahead of the snap elections that the country will hold on Sunday.

The anti-immigration Slovenian Democratic Party, led by ex-prime minister Janez Jansa, is expected to win the vote.

The central bank has warned that the new government must continue to run tight budgets and continue reforms as Slovenia's public debt remains high.

Elsewhere, Hungarian bonds should receive support from a possible upgrade in the country's credit rating by Moody's late on Friday, Raiffeisen analyst Imre Stephan said in a note.

He said an expected euro recovery would be a "major driver" in the Polish market, while the rising likelihood of two rate hikes in the Czech Republic would support the Czech market.

The Czech crown has been weaker than the central bank's forecasts, which has said that may lead to bigger and faster than expected rate hikes.

The region's main currencies shed 0.1 percent against the euro as the dollar resumed its firming in international markets.

Stocks mostly rose as the Italian developments improved mood in European markets. May PMI manufacturing indices in the region indicated continues robust growth, with a pick-up in the pace in Hungary and some slowdown in Poland and the Czech Republic.

Budapest's main index rose 1.9 percent, driven by a 2.7 percent rise in heavyweight OTP Bank, which fought itself back above the 10,000-forint ($36.57) level.

CEE MARKETS SNAPSH AT 1448 CET OT CURRENCIES Latest Previo Daily Change us bid close change in 2018 Czech crown 25.843 25.813 -0.11% -1.22% 0 5 Hungary 319.77 319.53 -0.07% -2.89% forint 00 50 Polish zloty 4.3150 4.3176 +0.06 -3.23% % Romanian leu 4.6662 4.6608 -0.12% 0.24% Croatian 7.3840 7.3885 +0.06 0.60% kuna % Serbian 118.05 118.08 +0.03 0.30% dinar 00 00 % Note: daily calculated previo close 1800 change from us at CET STOCKS Latest Previo Daily Change us close change in 2018 Prague 1078.7 1076.1 +0.24 +0.05 0 0 % % Budapest 36025. 35356. +1.89 -8.51% 58 83 % Warsaw 2164.1 2157.0 +0.33 -12.07 4 7 % % Bucharest 8080.1 8018.6 +0.77 +4.21 0 6 % % Ljubljana 889.86 881.69 +0.93 +10.3 % 5% Zagreb 1851.6 1854.0 -0.13% +0.47 2 2 % Belgrade 741.03 740.66 +0.05 -2.47% % Sofia 639.88 636.55 +0.52 -5.55% % BONDS Yield Yield Spread Daily (bid) change vs change Bund in Czech spread Republic 2-year 0.917 -0.08 +156b -12bps ps 5-year 1.418 0.008 +162b -6bps ps 10-year 1.953 0.01 +155b -5bps ps Poland 2-year 1.57 -0.005 +221b -4bps ps 5-year 2.417 -0.027 +262b -10bps ps 10-year 3.217 -0.057 +281b -12bps ps FORWARD RATE AGREEMENT 3x6 6x9 9x12 3M interb ank Czech Rep Hungary Poland Note: FRA are for ask quotes prices ********************************************************* ***** (Additional reporting by Marja Novak in Ljubljana Editing by Mark Heinrich)