* Poland leads bond yields rise on Italy-EU clashes over budget * Risks including China's economic slowdown weigh on equities * Polish retail sales lose pace, pointing to economic slowdown * Ruling party strength watched at Sunday's Polish local elections (Recasts with Polish bond yield increase, new comments) By Sandor Peto BUDAPEST, Oct 19 (Reuters) - Poland led a rise in Central European government bond yields on Friday as Italy's dispute with the European Union over its plan for higher budget deficits also boosted debt yields in the euro zone, with which the region's economies are tightly integrated.

Italian bond yields hit four-year highs after the EU crticised Rome's draft budget.

A 6 basis point rise in Poland's 10-year yield to 3.27 percent erased all the price gains the bonds posted since Standard & Poor's improved the country's rating to 'A-" a week ago.

The upgrade brought the rating level back to where it was before a shock downgrade in early 2016 due to the initial measures of the government led by the conservative PiS party.

S&P cited the robustly growing Polish economy, but its move surprised some investors who had believed that Warsaw's dispute with the European Commission over the rule of law in Poland would block an upgrade.

Hungary's 10-year yield was fixed higher by 5 basis points at 3.78 percent.

"This is partly Italy, and also positions are rearranged ahead of the long week-end (due to Hungary's Oct. 23 national holiday)," one Budapest-based fixed income trader said.

Polish bonds underperformed Hungarian peers which got a bad beating from a sell-off in emerging markets earlier this month when the U.S. 10-year Treasury yield surged to 7-year highs.

"(Friday's Polish yield rise) looks like a delayed reaction on global factors, including Italy, of course," Bank Pekao analyst Arkadiusz Urbanski said.

"(Polish bonds) remained stable, when core markets weakened," he said, adding that fresh supply at a Polish bond auction next week would arrive in an uncertain international environment.

Citi Group recommended that investors should underweight Hungarian bonds because they are vulnerable to yield rises in the United States and Italy.

"For EM (emerging markets) a lot is riding on whether the China (economic) stimulus is sufficient," Citi analysts said.

In Poland, September data showed a drop in the annual growth in retail sales rate to 5.6 percent from 9 percent in August.

The figures confirmed that the economy is slowing, and underpinned expectations that the Polish central bank would keep interest rates at record lows in the coming quarters.

Poland will hold the first round of local elections on Sunday. The fight for big cities including Warsaw is a key test to the ruling nationalist PiS party's support ahead of European Parliament and national elections next year.

The results are unlikely to affect markets seriously, senior economist of Credit Agricole in Poland, Warsaw-based analysts including Credit Agricole's Krystian Jaworski said.

"However, shall the voting reveal that there could be no clear winner of the 2019 parliamentary elections, the market could start pricing the political risk," said Marcin Sulewski, economist of Santander bank.

CEE SNAPSHOT AT MARKETS 1502 CET CURRENCI ES Latest Previous Daily Change bid close change in 2018 Czech Hungary Polish Romanian Croatian Serbian Note: calculated from 1800 CET daily change Latest Previous Daily Change close change in 2018 Prague 1081.28 1087.100 -0.54% +0.29% 0 Budapest 37078.65 37485.01 -1.08% -5.84% Warsaw 2180.37 2188.10 -0.35% -11.41% Bucharest 8594.12 8599.66 -0.06% +10.84% Ljubljana Zagreb 1767.27 1776.23 -0.50% -4.10% Belgrade Sofia 608.05 608.16 -0.02% -10.24% BONDS Yield Yield Spread Daily (bid) change vs Bund change in Czech spread Republic 2-year 5-year 10-year Poland 2-year 5-year 10-year FORWARD RATE AGREEMEN T 3x6 6x9 9x12 3M interban k Czech Rep 2.05 2.23 2.37 1.76 (PRIBOR= ) Hungary 0.40 0.68 1.03 0.16 Poland 1.78 1.80 1.89 1.72 Note: FRA are for ask prices quotes ************************************************* ************* (Reporting by Sandor Peto, editing by Ed Osmond and Angus MacSwan)