BUDAPEST: Hungary's central bank raised interest rates by 50 basis points on Tuesday and said more tightening may be needed to stem a market crisis in the eastern European Union member after a rating cut to "junk" that has hit its currency and debt.
The hike to 6.5 percent, the highest level in two years, was within market expectations but fell short of the bolder action some traders had called for to calm markets.
The forint, which fell to all-time lows against the euro earlier this month, lost 0.3 percent shortly after the decision while other central European currencies gained.
Hungarian assets have been under fire due to the right-of-centre government's unorthodox policies, including special taxes on mostly foreign-owned banks and utilities and a $14 billion nationalisation of pension fund assets to cover a budget gap.
Prime Minister Viktor Orban's approach, which goes against mainstream recommendations for tax hikes and spending cuts, sparked a downgrade by ratings agency Moody's to Ba1 last week.
The cut prompted a softening of the government's rhetoric on how it would negotiate a new aid deal with the International Monetary Fund.
Moody's said it saw a growing risk that Hungary will not be able to meet its fiscal targets in an environment of weak growth or even a recession, as forecast by the OECD and increased external market volatility amid the worsening euro zone crisis.
Central bank governor Andras Simor said Hungary needed to shore up its economic fundamentals to avoid speculative attacks.
"(Ukrainian world boxing champion) Vitali Klitschko is rarely smacked in the face on a street corner, but the bespectacled loser often is. Those countries are attacked on the markets whose fundamental situation is not strong," he said.
Simor said more rate hikes may be on the way if risk perception and the inflation outlook remain negative.
"In case inflation prospects and risk assessment were to remain persistently unfavourable in the coming months, further rate rises may follow," he added.
As the central bank met, the government debt agency sold all 40 billion forints ($173.09 million) of three-month treasury bills at an auction, with the average yield jumping 69 basis points from the previous sale a week ago, to 7.32 percent.
The next such test of market confidence will come on Thursday, when the government is due to offer 35 billion forints worth of three-, five-, and 10-year bonds.
Also on Tuesday, Hungary's parliament voted unanimously to lock in the basic parameters of the 2012 budget, which aims for an overall public deficit of 2.5 percent of gross domestic product. Its smooth approval had been expected given the ruling Fidesz party's strong parliamentary majority.
That deficit target may come under pressure due to currency weakness and a darkening growth outlook, however. The OECD predicted on Monday that Hungary's economy will contract by 0.6 percent next year.
Government bond yields, which raised in the morning on fears the rate hike, would be smaller than expected, fell after the decision and stood 10-20 basis point lower from early levels in late trade. The yield curve was almost flat around 9.2 percent.
"If this afternoon's 50 bps hike in Hungarian interest rates was intended to shore up the forint, the move has flopped," Capital Economics analyst Neil Shearing said.
"With the euro-crisis set to intensify and a deal with the IMF still some way off, we think there remains a greater than 50:50 chance that the National Bank will be forced into more aggressive interest rate hikes over the next 3-6 months."
The forint slid 0.3 percent to 309.5 versus the euro after the vote, and stands 10.2 percent lower this year, and near an all-time low of 317.9 hit on November 14.
The currency had gained ground on Monday, inspired by the government's pledge to mend relations with the IMF, retreating from an earlier line that any funding agreement had to come without any policy conditions attached.
That was a welcome line for investors from an administration that has spoken in favour of economic "sovereignty" and sees the Moody's action as part of a "financial attack" on Hungary.
Simor, often at odds with Orban's government, welcomed the decision to seek a new IMF deal, saying it could provide credibility.
In its post-meeting statement, the Monetary Council said it was important that the government reach an agreement with international organisations and the Hungarian Banking Association as soon as posReuters.
Orban has cut taxes for families and small firms while nationalising pensions and taxing big firms, putting the country of 10 million on track to run one of the European Union's only budget surpluses this year.
But his policies have failed to spur growth. Analysts have said Hungary needs to become more co-operative and accept more traditional tax and austerity measures.
Hungary's government debt stands at 82 percent of the country's gross domestic product, near the European Union average, but it is highly dependent on external funds and so hurt by the high yields.
Next year, Hungary needs to roll over 1.82 trillion forints in maturing debt and 1.37 trillion worth of foreign currency debt, including 3.34 billion euros worth of IMF funding.
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