Oct. 29 (Bloomberg) -- Hungary’s central bank will reduce the benchmark interest rate to as low as 6 percent next year and then halt its series of reductions to defend the forint and avoid jeopardizing financial stability, analysts said.

The Magyar Nemzeti Bank will cut the two-week deposit rate to 6.5 percent by the end of this year from 7 percent and to 6 percent in the first quarter of 2010, then keep it unchanged for the rest of the year, according to the median estimate of 10 economists in a quarterly Bloomberg survey.

Policy makers have cut 2.5 percentage points off the key rate since July to help the country overcome its worst recession in 18 years, which they expect will reduce the inflation rate to below the bank’s 3 percent target next year. Squeezing risk premiums on forint investments by lowering the key rate below 6 percent may reverse the currency’s gains, economists said.

“The forint is the reason the central bank won’t be able to cut rates below 6 percent,” Anette Skovgaard, an emerging- markets economist at Nordea Bank in Copenhagen, who forecasts a cut to 6.5 percent before the end of this year and 6 percent in the first quarter of 2010, said by phone. “Squeezing the risk premium further could weaken the currency.”

The forint has gained 16 percent against the euro since falling to a record of 317.22 on March 6 as the government shored up investor confidence by cutting spending to narrow the budget gap.

Budget Pledge

The government will be able to meet its pledge of limiting the budget shortfall to 3.9 percent of gross domestic product this year and 3.8 percent next year, according to the forecasts. The deficit may narrow to 3.1 percent in 2011, the survey shows, rather than the 3.2 percent average predicted three months ago.

The currency’s decline earlier this year prompted policy makers to halt rate cuts for six months on concern the forint’s weakness may spark defaults on foreign-currency loans, threatening financial stability.

Hungary was the first European Union country to secure an International Monetary Fund-led bailout last year after investors cited the country’s foreign-currency denominated debt for selling local assets during the credit crisis. Policy makers raised the key rate to 11.5 percent from 8.5 percent in October 2008 in an emergency move to stem the forint’s slide.

The central bank last reduced the interest rate on Oct. 19 to 7 percent from 7.5 percent. Further rate cuts now hinge on the country’s risk assessment as the recession keeps consumer prices in check, which would allow lower borrowing costs, Magyar Nemzeti Bank President Andras Simor said on Oct. 22.

Analysts expect the annual inflation rate to drop from an average of 4.4 percent this year to 4 percent in 2010 and 3 percent in 2011, the forecast show.

The economy will probably contract 6.3 percent this year and stagnate in 2010 before expanding 2.6 percent in 2011, according to a Bloomberg survey of 15 economists. That compares with the central bank’s forecast for a 6.7 percent decline this year and 0.9 percent in 2010 and growth of 3.4 percent in 2011.

To contact the reporters on this story: Zoltan Simon in Budapest at zsimon@bloomberg.net

Last Updated: October 28, 2009 19:00 EDT