(Adds prime minister quotes, background)
By Patrick Lannin and Sebastian Tong
RIGA/LONDON, June 2 (Reuters) - Fears that Latvia's currency could be devalued drove its interbank lending rates to a record high, pushed up the cost of insuring the country's debt and kept the lat at central bank support levels on Tuesday.
Swedish bank shares and the crown also fell again due to fears of exposure to Latvia, which last year had to agree a 7.5 billion euro IMF-led bailout, and the other two Baltic states. The three economies are expected to shrink by between 13 and 20 percent this year.
New devaluation fears were stoked by former Swedish central bank chief Bengt Dennis, now part of a group advising Latvian Prime Minister Valdis Dombrovskis. He said a change in the rate of the lat's peg to the euro was only a matter of time.
"...I think we have moved past the issue of if there will be a devaluation and should concentrate on how it should be carried out," Dennis said in a recording of the comments posted on public service television SVT's website.
Although the prime minister distanced the government from the comment, and Dennis himself told Reuters it was mistakenly interpreted as an official stance, the remark stoked worries about keeping the lat pegged given that the economy is set to shrink 18 percent this year and the government is scrambling for budget cuts to meet the terms of the rescue package.
The debate has reached the government as the justice minister, from the largest party in the coalition, on Monday became the most senior official to say the impact of a devaluation should be examined.
The central bank last week spent 134 million euros to buy lats to support the peg, its highest intervention this year.
GOVERNMENT FIRM
Prime Minister Valdis Dombrovskis, in a statement, rejected Dennis's words, saying they were his personal opinion and not part of the work of the group of advisers.
"The negotiations of the government of Latvia and international investors are based on a requirement of a stable national currency, that all parties comply with and confirm."
He said he hoped to receive a next tranche of funds of 1.2 billion euros in July from the International Monetary Fund and European Union, part of the rescue programme and needed to stop what Dombrovskis has said would be Latvia's bankruptcy.
Concerns about devaluation, the IMF programme and heavy interventions by the central bank to keep the lat within its 1 percent fluctuation band against the euro pushed up Latvian overnight lending rate to a historic high of 16.1 percent, up from 14 percent on Monday.
Some analysts said they had seen prices quoted as high as 80-100 percent for overnight borrowing.
"Dennis saying (Latvia) should devalue really marks a change. It's now become acceptable for the Swedish establishment to talk about devaluation ... they are preparing the markets," said Danske chief emerging markets analyst Lars Christensen.
Five-year credit default swaps (CDS) for Latvia were quoted mid-price at 640 bps, meaning it costs 6.4 cents to insure each dollar of debt, up from the previous close of 609.7 bps. Lithuania CDS traded at 430 bps, up from 410 bps, while Estonian CDS were quoted at 311.8 bps, up 4 bps, said CMA Datavision.
Swedbank and SEB, the Swedish banks most exposed to the Baltic and possible defaults, saw their shares fall 4.6 percent and 2.6 percent respectively.
Bank shares were also hit after the Swedish central bank said they faced surging loan losses due to the Baltic woes.
"Investors believe that if Latvia devalues, other countries in the Baltics and Bulgaria may have to follow, as they have similar exchange rate regimes," said Bartosz Pawlowski, emerging markets strategist BNP Paribas.
Nordea Markets Latvia currency analyst Andris Larins said interbank rates were set to stay high and expected the central bank had again been intervening to support the lat.
"The behaviour of lat market interest rates is similar to the December events (when Latvia took its IMF loan)," he wrote in a note. The central bank buys lats when the euro hits 0.7098 lats, the top end of the 1 percent band. (Reporting by Carolyn Cohn and Paul Lauener in London and Jorgen Johansson in Riga; writing by Sebastian Tong; Editing by Ruth Pitchford)