Hungary raises interest rate to EU record high to shield forint

Struggling Hungary has moved to raise its benchmark interest rate from 6% to 6.5%, the highest ever level seen in the European Union, in order to protect its currency.

Last week, Hungary's credit rating was downgraded by Moody's by one notch to Ba1.

Shortly afterwards yields on the country's government bonds rose to their highest since February, at 9.87% on five year bonds, while the forint fell to its weakest ever level against the euro at 317.92 in mid-November.

The forint is the world's worst performing currency against the euro in the second half of this year, according to Bloomberg data.

Bond investors have long been cautious on Hungary, which was badly damaged post-Lehman, and has been subject to a series of high risk and unorthodox policy actions by its government.

Hungarian debt has recently sold off aggressively, with the yield of the J.P. Morgan GBI-EM Hungary index reaching a yearly high of over 8% in early November.

As a result some emerging market debt investors have been tempted to buy into Hungarian government bonds, including Investec's head of emerging market debt Peter Eerdmans, who said news of Hungary asking the International Monetary Fund and the EU for help had boosted its investment case.

News of Hungary's appeal to the IMF and EU emerged last week, but the IMF later denied the talks.

"Help from the EU and IMF could lead to the removal of some substantial risks (mainly liquidity risks, high refinancing needs and excess currency weakness), which could open the door to excellent future returns consistent with the economy's improving fundamentals," he said.

However, other emerging market debt investors remain cautious, including Aberdeen EM debt head Brett Diment, who sold out of his entire Hungary exposure earlier this year.

At a government bond auction today, Hungary sold a planned 40bn forint ($173m) of three-month Treasury bills at an average yield of 7.32% today, compared with 6.63% at the last sale of the same maturity on November 22.

The government failed to sell a planned 50bn forint of debt yesterday, auctioning 35bn forint of six-week Treasury bills as yields soared.