WRAPUP 1-Hungary political woes drag down C.Europe markets

By Sujata Rao

LONDON, Sept 19 (Reuters) - Central European markets tumbled on Tuesday as an unfolding political scandal and rioting in Hungary prompted investors to flee currencies, stocks and bonds across the region.

The riots followed the leak of a tape on Sunday in which Prime Minister Ferenc Gyurcsany said he and his Socialist party had lied for four years about Hungary's budget in order to win a general election last April.

The prime minister 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 forint fell 1 percent to 273.68 per euro <EURHUF=> while the Budapest stock market <.BUX> tumbled almost 2 percent. Bonds also sold off, with yields up 12 basis points across the curve.

The weakness spilled over into neighbouring states, with the zloty slipping 0.3 percent to 3.96 per euro <EURPLN=>. The Czech and Slovak crowns <EURCZK=> <EURSKK=> also weakened slightly.

Bonds fell across the region, with Polish and Slovak five-year yields up almost 10 basis points. The Warsaw <.WIG20> and Prague bourses were down over one percent <.PX>.

"It's all about Hungary today. There are a lot of political issues on the boil throughout central Europe but there is no question that Hungary is acting as the trigger and having an acute impact on the whole of central Europe," said Juliet Sampson, emerging markets strategist at HSBC in London.

Sampson said markets were becoming increasingly nervous that Gyurcsany will be forced out of office, potentially endangering the future of the much-needed reform programme.

"The credibility of the reform programme is tied up with his position, that's why we are seeing the forint backfooted," she said. "If he goes any successor would have an even greater challenge in establishing and maintaining credibility."

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.

Mats Olausson, strategist at SEB in Stockholm saw rising inflation, euro zone delays, a possible downgrade by rating agency Moody's and October local elections as near-term risks.

"Rumours that the PM may have to step down increases the political risk premium further and gives a good momentum to re-establish a bearish position in bonds and the currency," he said in a note to clients.

He also suggested a short 5-year forint bond position against Bunds, betting spreads will widen by over 40 bps.

POLITICS ACROSS THE REGION

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

Elections in all the region's countries in the past year have yielded fractious coalitions that include radical parties keen to raise social spending and block privatisations, moves that have the potential to undo the gains of recent years.

In Poland, for instance, ruling conservatives are wrangling with leftist coalition partners who threaten to block the budget and trigger early elections if social spending is not raised.

"Throughout 2006 it has been the case that we had a general backtracking of (euro zone accession) timings for the region," said Martin Blum, head of FX strategy at Bank Austria CA-IB in Vienna. "For central Europe as a whole, politics are a headwind and something that's worrying longer-term investors.

The years of ultra-low inflation also seem a thing of the past and likely interest rate rises will impact bond markets.

"There is a risk to bond markets. Convergence investors, real money funds etc will stay engaged in central Europe so we won't see a massive withdrawal, but some scaling back is inevitable," said Jon Harrison at Dresdner Kleinwort in London.

((Reporting by Sujata Rao London newsroom +44 20 7542 6176 sujata.rao@reuters.com;editing by Ian Jones))

Keywords: MARKETS C.EUROPE HUNGARY