UPDATE 1-Hungary c.bank soldiers on with rate cut to new low of 2.85 pct

Tue Jan 21, 2014 8:15am EST

Related Topics

* Central bank cuts rates by 15 basis points to 2.85 pct

* Policymakers have said rates could fall as low as 2.5 pct later

* December inflation sank to 43-year low of 0.4 pct, seen benign

* Analysts see rates bottoming out at 2.7 pct - Reuters poll

By Gergely Szakacs

BUDAPEST, Jan 21 (Reuters) - Hungary's central bank cut its main interest rate by 15 basis points to a new low of 2.85 percent on Tuesday, trimming the scale of its recent cuts and suggesting the bank may be nearing the bottom of a long, steady rate-cutting cycle.

The bank's Monetary Council, all appointed under Prime Minister Viktor Orban's government, cut rates again despite the forint's modest weakening as inflation hangs at 43-year lows and the cost of insuring Hungarian debt against default is near a four-year trough.

The council may also have been encouraged to cut rates below 3 percent, where it has previously suggested it may end its run of rate cuts, by the benign market reaction to the U.S. Federal Reserve's move to start reducing its monetary stimulus.

Tuesday's cut was slightly larger than most analysts had expected in a Jan. 13-16 Reuters poll. Sixteen of 20 analysts forecast a 10 basis-point cut, while four had predicted another 20 basis-point reduction. No one had 15 basis points pencilled in.

In all, the panel has now reduced rates by 4.15 percentage points from their August 2012 peak, and the bank led by Orban ally Gyorgy Matolcsy has also launched an up to $12.3 billion stimulus programme to boost the economy.

Orban, who says he has saved Hungary from a Greek-style collapse since taking office four years ago, will fight for re-election in April.

The central bank's long run of rate reductions may help his efforts to drag Hungary's economy out of a prolonged malaise.

The forint has eased 1.4 percent against the euro since the December rate meeting, trading on the weaker side of the psychologically key 300 level. At 1308 GMT, it traded at 302.65 compared with 302.80 before the rate decision.

Central bank Deputy Governor Adam Balog told Reuters in an interview early this month that rates could go as low as 2.5 percent, matching the rate in regional heavyweight Poland, which has a stronger economy and an investment-grade credit rating.

Most analysts say rates are likely to bottom out at 2.7 percent, but their expectations have shifted lower and lower in recent months as the bank sought to guide market expectations.

"Our baseline scenario envisages that the MC will continue lowering the policy rate by 10 bps each month, with a view to reaching 2.5 percent and then keeping it unchanged for the rest of 2014," said analyst Gergely Hudecz at Credit Suisse.

"The MC might tolerate a gradual weakening of the forint's exchange rate, but it could end the easing cycle earlier if the forint depreciates sharply versus the euro, in our view," Hudecz said.

Further ahead, analysts polled by Reuters expect the bank to begin raising rates around the end of this year as central banks in developed markets consider tightening policy and investors start to expect higher yields.

ORDERLY CHANGES

Central bankers have said the forint factors in their outlook on rates only to the extent that it influences price developments. They have also said they would not react to gradual and orderly shifts in the exchange rate.

Hungary covered most of its foreign currency borrowing needs for the first half of 2014 with a $2 billion dollar bond issue in November. Domestic debt tenders remain well-bid and five-year credit default swap levels are near four-year-lows.

A plunge in inflation to a 43-year-low of 0.4 percent in December, largely due to government-imposed cuts in household energy prices and a decline in food prices, has also given the bank room to cut rates steadily.

The bank expects inflation to remain below its 3 percent medium-term target both this year and next.

Close trade links with the euro zone's recovering economies have shielded central European currencies from the wobbles seen in other emerging markets in recent months, while Hungary's current account surplus adds to the forint's stability.

By contrast, Turkey's lira hit a new record low after its central bank kept rates on hold on Tuesday, as the market had expected substantial rate hikes to defend the currency and fight inflation.

But some analysts say more rate cuts could hurt the Hungarian currency.

"Continued interest rate easing and populist measures in Hungary are likely to further undermine HUF over the coming months," said analyst Phoenix Kalen at Societe Generale. ($1 = 222.68 Hungarian forints) (Editing by Hugh Lawson)

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