Hungary inches nearer IMF deal, central bank talks up forint

BUDAPEST Tue Jan 10, 2012 5:22pm GMT

European Union Economic and Monetary Affairs Commissioner Olli Rehn addresses a news conference on the entry of the fiscal compact and the ''six-pack'' in Brussels December 12, 2011. REUTERS/Thierry Roge

European Union Economic and Monetary Affairs Commissioner Olli Rehn addresses a news conference on the entry of the fiscal compact and the ''six-pack'' in Brussels December 12, 2011.

Credit: Reuters/Thierry Roge

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BUDAPEST (Reuters) - The National Bank of Hungary gave the ailing forint verbal support on Tuesday, while the foreign minister said the government would consider modifying disputed laws, suggesting it may be ready to alter a law seen as infringing on the central bank's independence.

The forint gained 1.7 percent from Monday's close and government bond yields dropped about 25 basis points after the comments, which come as Hungary begins talks with the International Monetary Fund in Washington over a new funding deal needed to avert a market meltdown.

In an extra statement after its regular non-rate meeting, the bank, which raised rates by 50 basis points to 7 percent last month to support markets, said the persistent weakness of the currency could worsen the economic and inflation outlook and might cause disruptions in the financial system.

The forint hit new record lows versus the euro last week and bond yields surged above 11 percent due to uncertainty over Hungary's plans to secure a new financing deal with the IMF and European Union.

The government, bending to market pressure, has since pledged to seek a new funding deal quickly, which has helped the forint and bonds recoup some of their losses this week.

"Monetary policy can best support the recovery by maintaining a predictable economic environment, ensuring price stability and preserving the stability of the financial system. If necessary, the Monetary Council stands ready to meet these objectives using the instruments at its disposal," the bank said in a statement.

Separately, in a letter to EU partners and the European Commission, Hungary's foreign minister said the government was ready to consider modifying disputed legislation if the Commission deems it necessary, raising hopes in market players that Hungary was inching closer to a new agreement.

"We stand ready to consider changing legislation, if necessary. This has never been and will not be a matter of prestige for my government," Martonyi wrote in the letter dated January 6 and published by his ministry on Tuesday.

Martonyi rejected criticism that the government had used its two-thirds parliamentary majority to cement its powers in a new constitution and said it was unacceptable for anyone to question Hungary's democratic commitment.

The new IMF/EU funding deal is crucial for the country to keep financing its debt from markets, after serious policy mistakes by the conservative government that have undermined investor confidence and sapped its popular support.

One of the key issues at the negotiating table will be a new law affecting the central bank, which the IMF and EU said infringed the bank's independence, and which led to a breakdown of earlier talks in December.

Investors holding billions of dollars worth of Hungarian debt want reassurance that the Hungarian government will act on its words and meet lenders' demands to change some of its unorthodox economic policies in order to secure the deal.

EU Economic and Monetary Affairs Commissioner Olli Rehn will meet Hungarian officials on January 20.

The minister in charge of Hungary's negotiating team, Tamas Fellegi, is in Washington this week with a mandate to accept a precautionary International Monetary Fund loan with stricter conditions than Budapest originally wanted.

"The talks will start today with meetings with senior management and officials," an IMF spokesperson said, adding that Fellegi would meet IMF chief Christine Lagarde on Thursday.

VERBAL INTERVENTION

The central bank's Monetary Council welcomed the government's commitment to reaching a fast agreement with the International Monetary Fund and the EU on financial support.

Markets expect the bank to raise interest rates when it holds a regular rate meeting on January 24, but analysts said an extraordinary rate hike could not be expected as markets have calmed down, unless the forint and bonds plunge again.

"The market reaction shows that the market has taken this (bank statement) as a verbal intervention," said Gergely Szabo Forian, Pioneer Investments.

"This can be interpreted as a verbal intervention but does not indicate that there would be an emergency rate hike on the way," said Zoltan Arokszallasi at Erste Bank.

"We think that if the government acts as it says and secures a deal then two more rate hikes to 8 percent will be sufficient (to shore up markets)."

Hungary's debt rating was cut to BB+ by Fitch on Friday, the third downgrade to "junk" by international rating agencies since November.

"All in all, a deal now looks closer than it has done for some time but it would be complacent to think that there are no further obstacles ahead and that a deal can be secured quickly,"

Capital Economics said in a note on Tuesday.

It expects the central bank to hike rates by a further 50 basis points at its next meeting later this month.

(Reporting By Robin Emmott, additional reporting by Krisztina Than in Budapest editing by Charlie Dunmore)

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