UPDATE 1-World Bank slashes Russia growth forecasts

(Adds detail from report)

* Cuts 2012 growth forecast to 3.5 pct, 2013 to 3.6 pct * Inflation to overshoot target * Tight labour market threatens competitiveness * Government should "build buffers" against shocks By Maya Dyakina and Douglas Busvine

MOSCOW, Oct 8 (Reuters) - The World Bank slashed its economic growth forecasts for Russia on Monday and cautioned that labour shortages would force up inflation even as the world's ninth-largest economy slows.

The global development lender cut its forecast for economic growth this year to 3.5 percent from 3.9 percent previously, down from last's year's growth of 4.3 percent. It lowered its 2013 outlook to 3.6 percent from 4.1 percent.

"Whereas early in the year, growth was rising and inflation declining, now growth is declining and inflation rising," the World Bank said in its twice-yearly Russian Economic Report.

"A challenging external environment and worsening sentiment among businesses and consumers translate into weak growth prospects."

Stripping out the crisis years of 1998 and 2009, Russia's economy will grow at its slowest rate in a decade and a half even though the price of the country's main export - oil - is near record levels, the bank noted.

Despite the loss of momentum, the bank expects the tight jobs market, a bad grain harvest and hikes in household utility bills to push inflation to 6.5-7 percent by the end of 2012.

Consumer price growth will stay above the central bank's target of 6 percent going into 2013. The central bank hiked interest rates last month, in a move praised by the World Bank as helping put growth on a more sustainable footing.

Russia's jobs market is tight, indicating that the economy is overheating in key sectors, the World Bank said. That has pushed the headline rate of unemployment down to 5.2 percent - less than the trough that preceded the 2008 financial crisis.

Labour shortages have driven wage growth to 10 percent in the first eight months of this year - outstripping productivity gains threefold and threatening to undermine Russia's economic competitiveness.

For now, Russia's public finances remain strong and the current account surplus - even as it shrinks to a forecast 2.8 percent of gross domestic product next year from 4.1 percent this year - will more than cover expected net capital outflows.

But a 29 percent rise in nominal state spending that preceded Vladimir Putin's return to the Kremlin this year has left Russia more dependent than ever on high oil prices to balance the books.

Stripping out oil and gas revenues, Russia would run a fiscal deficit of 10.5 percent of GDP this year, up from 7.5 percent of GDP last year, the World Bank estimates.

Its forecast rests on an assumption that oil prices will hold at around $105 per barrel, leading the World Bank to conclude that the Russian economy "remains vulnerable to terms of trade shocks".

The World Bank urged policy makers to build buffers against external shocks that might hit Russia if the West fails to come to terms with its sovereign debt crisis.

Spelling out its recommendations, the bank said Russia should replenish the funds that save windfall oil revenues to insure the budget against a rainy day, strengthen the central bank's focus on inflation and tighten banking supervision.

(Writing by Douglas Busvine; Editing by Megan Davies/Jeremy Gaunt)

((douglas.busvine@thomsonreuters.com)(+7 495 775 1242))