UPDATE 2-Defying jittery markets, Hungary keeps option of more rate cuts
* Central bank cuts by 15 bps to new low of 2.7 pct
* Says will decide on whether to continue easing next month
* Door still open to further rate cut -analysts
* Inflation at zero in January, economy recovering
* But forint weak, vulnerable to emerging market sell-offs
By Krisztina Than
BUDAPEST, Feb 18 (Reuters) - Hungary cut interest rates to a new record low on Tuesday and said it may ease again, defying warnings from markets and even the economy minister about contagion from emerging markets if the cycle is not halted soon.
The 15 basis point reduction in borrowing costs to 2.7 percent was bigger than the 10 bps most analysts had expected.
In a nod to fears that turbulence affecting other emerging markets such as Turkey and South Africa could engulf Hungary, the central bank did adopt a slightly more cautious tone, saying it would review in March whether more cuts were needed.
But that was not enough for many in the markets, who had been looking for an unequivocal indication of when the prolonged rate-cutting cycle would end, and the forint fell more than half a percent to 310.50 versus the euro after the cut was announced.
"What they say now can mean any kind of decision, they left a wide manoeuvring room for themselves," said K&H Bank analyst David Nemeth. "If the international environment and (Hungary's) risk assessment improves, they will cut rates further."
The comment in the bank's post-meeting statement was the first signal that it might end the sequence of monthly cuts that began in August 2012, when its main interest rate was 7 percent.
The bank's policymakers, all appointed under Prime Minister Viktor Orban, appeared to have ignored a warning by Economy Minister Mihaly Varga that the base rate at its existing level was already "less appealing to investors".
In its statement, the central bank said it would "decide on the need and possibility for continuing the easing cycle" after assessing the outlook for the economy in March, when it is due to release fresh inflation forecasts.
Led by ex-economy minister and Orban ally Gyorgy Matolcsy, the bank has said it is able to make deep rate cuts to stimulate economic growth because inflation is at more than 40-year lows.
Inflation ran at zero in January after government-imposed energy price cuts, but is forecast to accelerate to 2.5 percent by year-end, meaning interest rates now offer only a tiny pick-up over expected inflation.
Many economists say the benefit to growth from continuing with incremental rate cuts is now marginal and is outweighed by the risk that low returns for investors will hurt the forint.
The Hungarian currency fell to two-year lows around 314 to the euro this month and is now firmly on the weaker side of 300. A weaker forint would push up repayments on households' foreign currency loans and could become a hot political issue ahead of parliamentary elections in April.
Other central banks in the region, including Poland, seen as central and eastern Europe's strongest economy, have already ceased cutting as global markets fret about the impact of U.S. stimulus withdrawal and a possible economic slowdown in China.
It was not immediately clear why the bank was persisting with the cuts in the face of market anxiety, although the move typified the go-it-alone style of economic policy that Hungary under Orban has pursued - often to the consternation of markets and international financial institutions.
Hungary's base rate is now at a level which analysts polled by Reuters last week saw as the bottom of the cycle.
"Their belief in it being a one-off wobble (in markets) is evidently still there. We stick with a 2.50 base rate view," said Peter Attard Montalto at Nomura.
"They want to sound cautious to try keep markets onside. But I wouldn't say they flagged a possible end of cycle at all."
Emerging Europe's highest debt burden also makes Hungary vulnerable to any sudden souring of investor sentiment, even with its current account surplus and stable budget, and its reliance on foreign financing means a tumble in the currency could trigger a sell-off in Hungarian bonds.
That in turn could force the central bank to make an emergency rate hike, as Turkey and South Africa did last month, and as Hungary has done before - most recently in 2008 when it took an International Monetary Fund bailout. (Editing by Catherine Evans)
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