* Rate cut scope supports Hungarian, Romanian bonds
* End of Polish cuts tempers growth view, zloty outperformer
* Markets bearish on Czech debt before October poll
By Jason Hovet
PRAGUE, Sept 1 (Reuters) - The prospect of rate cuts in
Hungary and Romania is likely to stay in bond investors' sights
in the final months of the year, setting up debt markets there
to outperform their economically sounder central European peers.
Despite signs the worst of the crisis has passed over
central Europe, Hungary and Romania's economic outlooks remain
bleak. Their main interest rates, at 8 and 8.5 percent, are the
highest in the European Union even as their economies contract
sharply, and they have the most room to fall.
In contrast, rates in Poland, the only country in the region
to avoid recession, and the Czech Republic, are at record lows.
While Poland's stronger than expected second quarter growth
of 1.1 percent bodes well for that country's spiralling budget
deficit, it has pretty much ended hopes the central bank will
continue monetary easing and pushed shorter-dated bonds weaker.
Meanwhile, the Czechs officially exited recession in the
second quarter, and better growth prospects are seen keeping
rates unchanged at the region's lowest level of 1.25 percent.
"There are bright spots on the bond market side, so we quite
like Romania and Hungary just because they still have potential
for reasonable rate cuts," said Caroline Gorman, who helps
manage a $1.6 billion EM debt fund at Augustus Asset Management.
She added she preferred Hungarian bonds, especially on the
short-end of the curve, to those in Poland, which still faces
inflation threats which will hold the central bank's hand.
Moreover, analysts note another support is Hungary's $25
billion International Monetary Fund package that limits issuance
at a time of growing demand for domestic funds.
DIVERGENCE PLAYS
While the divergence in Hungary and Poland's interest rate
outlooks help the short-end of Hungary's bond curve outperform,
UniCredit emerging markets strategist Gyula Toth said it would
conversely benefit Poland's zloty against the Hungarian forint.
"Betting on the fact that Poland is very likely finished
with rate cuts while Hungary is cutting even more, this is
definitely a potential play on these diverging economic and
monetary policy outlooks," he said.
A Reuters central European currency poll in August showed
the zloty as the region's outperformer, while the forint was
seen slipping to 275 per euro over the next three months. On
Tuesday it traded at around 274.
Poland's stronger growth -- evident in the second quarter
when the economy rose at twice the pace analysts had forecast --
could limit bond issuance going ahead, favouring the long end of
the yield curve.
In Romania, with a less developed market and the backing of
a 20 billion euro IMF package, Societe Generale EM fixed income
strategist Esther Law said the short-end of the curve showed
more reward due to market uncertainty on rate cuts.
"In Romania it is a bit difficult to judge how many cuts are
priced in," she said, adding the curve there adjusts the most in
the region after rate moves.
Analysts, though, are bearish on Czech debt due to lower
yields and budget concerns as a caretaker government struggles
to control the budget gap before an October election.
Still, with correlations to German bonds in the region being
knocked out in the past year, Erste Group recommended long
positions in the Czech 9-year <CZ9YT=RR> against the German
10-year <DE10YT=RR> due to a re-tightening spread, which has
been cut to around 160 basis points from almost 250 in April.
BULL RUN
In Hungary and Romania, bond yields have dropped to around 8
percent and 10 percent along flattened curves, down from peaks
of 14 percent in February and March when the crisis made credit
more scarce and expensive for struggling emerging countries.
Fears of financial instability had delayed monetary easing
in the first half of the year, but many analysts now pencil in
around 100 basis points in interest rate cuts this year.
Questions remain how much fresh cash will go to central
Europe, which investors have shunned somewhat compared to other
emerging countries in Asia or Latin America that show better
growth prospects.
And budget gaps are still running high. The government
deficits in Poland and the Czech Republic are expected to double
the EU's 3 percent ceiling despite the better growth outlooks.
"The region is stabilised but it is clearly not showing this
turnaround momentum like other regions in emerging markets, such
as Asia," Commerzbank's head of emerging markets research,
Michael Ganske said.
