WRAPUP 2-Signs of recovery after Hungary hits C. Europe markets

(Recasts, adds analyst comments, changes byline)

By Daniel Bases

LONDON, Sept 19 (Reuters) - Central European financial markets showed pockets of recovery after Tuesday's broad-based sell-off following political turmoil in Hungary, helped by benign U.S. inflation data.

Hungary has long been held out as the central European nation with the deepest fiscal problems and therefore much of the early rush from its markets may have been exhausted because investor positioning was already light.

Prime Minister Ferenc Gyurcsany said he would not resign in the wake of riots in Budapest following revelations that he and his Socialist party lied about Hungary's budget to win a general election in April.

"The forint looked like it would sell-off sharply but then it came back. One reason is likely the benign U.S. inflation data, which is generally good for risky markets," said Beat Siegenthaler, senior strategist at TD Securities in London.

U.S. producer prices were unexpectedly weak in August while housing starts last month fell to their lowest level since April 2003, fuelling more speculation that U.S. benchmark interest rates won't rise from their current level of 5.25 percent.

"And I also think there is a general shrugging of the shoulders in Hungary with people underweight. The easily scared-off money is already long gone and anything that is there has to be there," Siegenthaler said.

Gyurcsany won the election partly on a promise of tax cuts. But he has since imposed tax rises and benefit cuts worth $4.6 billion in 2007 alone to curb a budget deficit which will surge to 10.1 percent of gross domestic product this year, the biggest in the European Union.

The Budapest stock market's main index <.BUX> lost 1.21 percent, cutting in half earlier losses while Poland's main index <.WIG20> fell 0.87 percent on the day. Prague's main stock index <.PX> cut its losses but ended down 1.03 percent.

The forint lost ground against the euro, falling to a weekly low of 274.75 <EURHUF=> before gaining back some ground to trade off 0.86 percent on the day at 273.35.

TOO OPTIMISTIC

Some analysts say markets seem too sanguine about the risk.

"The markets appears to be assessing the balance of risks too optimistically. With a fiscal consolidation package at stake, political turmoil in Hungary should be taken more seriously than political tensions in other countries," said Radoslaw Bodys, central European economist and strategist at Merrill Lynch in London.

"It doesn't matter who is prime minister in Poland but it does matter in Hungary.... If (Gyurcsany) goes the fiscal package goes with him," he said.

Hungary's woes are the latest in a long list of political problems that are making investors sceptical about the region's commitment to reform and euro currency adoption targets.

Collateral damage, albeit limited, was felt in other central European currencies, but traders and analysts alike said it was more a function of market psychology than anything fundamental.

The Polish zloty fell to a weekly low of 3.9708 <EURPLN=>, before regaining ground to trade down 0.25 percent at 3.9530.

The Czech crown was in better form, trading down just 0.06 percent on the day to 28.45 per euro <EURCZK=>. The Slovak crown lost 0.15 percent to 37.44 against the euro <EURSKK=>.

Government bonds also largely recovered as risk aversion dissipated, with some gains for Hungary's 10-year government issue <HU10YT=RR>. Polish 10-year bonds cut early losses while Czech 10-year bonds were steady <CZ10YT=RR>.

Hungary is central Europe's worst performing market this year because of its fiscal problems, but has been living on borrowed time economically for years.

Gyurcsany has announced hefty tax rises and budget cuts to bring the deficit under control though most economists were disappointed with the package which is seen likely to boost inflation and force the central bank to raise rates further.

That is seen impacting on local bonds where yields have already risen 250 bps since last September. ((Reporting by Daniel Bases and Sujata Rao; Editing by Ian Jones; Telephone: +44 207 542 2464; e-mail: daniel.bases@reuters.com; Reuters Messaging: daniel.bases.reuters.com@reuters.net))

Keywords: MARKETS C.EUROPE HUNGARY