Hungary move to prompt C. Europe forex rethink

By Sebastian Tong

LONDON, Feb 25 (Reuters) - Hungary's surprise move on Monday to abandon its currency band is unlikely to derail plans by its central European peers to adopt the euro but could prompt some of them to switch to more flexible exchange-rate systems.
Analysts say Hungary's sudden decision to replace the forint's trading band against the euro with a free-float regime underscores the difficulties faced by some euro zone aspirants in meeting inflation targets set by the European Union.
Faced with a slowing economy and rising inflation, Hungary ditched the forint's 30 percent trading band against the euro -- an arrangement in place since 2001 -- saying that the change would enable the central bank to use its monetary policy more effectively to manage inflation. [ID:nL25162043]

Some would-be euro zone members face similar, though not identical, exchange-rate constraints but further inflation shocks could nudge those with exchange-rate bands or currency pegs towards greater flexibility.
Bulgaria, Estonia, Latvia and Lithuania, which have currency pegs to the euro, could consider a currency adjustment if inflation were to rise further, analysts said.
"If inflation is due to external factors then you need an exchange rate mechanism to deal with it but countries don't have any tools to deliver a response to domestic inflation if their currencies are pegged," said Commerzbank strategist Barbara Nestor.
Ratings agencies have warned Bulgaria and the three Baltic states that they face an abrupt and painful slowdown because of their rapid growth and huge current account deficits.
Bear Sterns' Emerging Europe Economist Tim Ash said the Hungarian move could intensify a brewing debate within Ukraine -- which has declared its interest in the currency union -- over its exchange-rate band for its hryvnia currency.
"Ukraine might come under pressure to widen its trading band more towards appreciation, in order to deal with its inflation," said London-based Ash.
NO EURO WAVE
However, analysts don't see immediate currency regime changes among these countries as policymakers are more likely to allow the expected global economic slowdown to work its way into their economies and dampen price rises.
The Hungarian move is seen having minimal impact on euro zone candidates that have more flexible exchange rate regimes.
Slovakia, which has enjoyed strong economic growth, remains on track for euro accession, analysts said, and is expected to reach an end-July agreement with the European Union on its currency conversion rate to the euro.
However, Lars Christensen, Stockholm-based head of emerging markets research at Danske Bank, said Hungary's surprise decision on its currency suggests that inflation is likely to trip up euro zone ambitions.
"Having admitted countries in the past with monetary policy that was too loose -- Slovenia, Spain and Ireland -- the European Central Bank is now looking for real convergence rather than nominal convergence."
"We have to face up to the fact that we're not standing in front of a wave of countries adopting the euro." (Reporting by Sebastian Tong; Editing by Ron Askew)