By Helen Reid

LONDON (Reuters) - Post-communist countries in Europe have made significant headway since transition, but inequality poses a growing threat to long-term development, a report from the European Bank for Reconstruction and Development said on Thursday.

Since the late 1990s, average incomes in the mainly central and eastern European region covered by the bank have grown significantly and poverty has diminished, but lack of recognition of the gains has created problems.

Despite official data indicating no clear trend in recent years and inequality being low by international standards, most people believed it had actually increased.

"Excessive concentration of wealth (among the very rich) ... may negatively affect equality of opportunity and cause a backlash against key economic and political institutions underlying market economies," the bank warned, adding it could lead to weaker growth in the long run.

The shock of transition and the unequal distribution of its benefits give politicians an anti-reform narrative, ultimately resulting in threats to democracy, the bank said.

"Potential losers in such reform processes should be given not only one-off compensation, but also the skills necessary to ensure their future employability," the bank recommended.

Inequality of opportunity also remained higher in the EBRD region than in western European countries. Gender and communist party membership among older residents still contributed to determining life chances.

The EBRD was set up in 1991 to invest in the former Soviet economies of central and eastern Europe. It has grown considerably over the last decade and now spends around 9 billion euros ($9.98 billion) a year in 36 countries from Morocco to Mongolia.

The new 'Transition' report highlighted how its core region has achieved an impressive amount of income convergence with advanced economies since the late 1990s.

A so-called "happiness gap" had finally closed with western European citizens in the EBRD's latest survey, although this convergence partly reflected a decline in happiness in advanced economies.

The gap was measured in a survey of 51,000 households in 34 countries conducted in 2006, 2010 and 2016, asking respondents to rank from 1 to 5 their agreement with the statement "All things considered, I am satisfied with my life now".

The report also found the transition had various effects. Political turmoil and price liberalization entailed significant deprivation, while generations that grew up during the peak of the changes were found to be over 1 cm shorter on average.

"When income is controlled for, satisfaction levels among residents of post-communist countries are now similar to those of their western European peers - and even higher than those of people in Cyprus, Greece and Turkey," the report said.

But individuals' experiences of growth differed markedly depending on their position on the income ladder.

Only those in the top 27 percent of income distribution experienced average or above-average income growth. Some 23 percent were actually worse off now than in 1989, while 33 percent experienced income growth below the G7 average.

(Reporting by Helen Reid, editing by Larry King)