Hobbit is an invention. In the Westron the word used, when this people was referred to at all, was banakil ‘halfling’. But..the folk of the Shire and of Bree used the word kuduk... It seems likely that kaduk was a worn-down form of kûd-dûkan [= ‘hole-dweller’]. The latter I have translated... by holbytla [‘hole-builder’]; and hobbit provides a word that might well be a worn-down form of holbytla, if the name had occurred in our own ancient language.
You gotta love someone who says "it seems likely" about languages he invented himself.
His holbytla is from Old English hol "hollow, cavern, den", and bytla "hammerer, builder". Hol (and modern hole) is from Proto-Indo-European *ḱel- "to cover, conceal" (which I've talked about before, but anyway).
In Latin, *ḱel- prefixed with *ob- "over" to form occulere "to cover over", and the past participle occultus, and English occult.