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The Magyar Nemzeti Bank provided its 12th consecutive lending rate cut on July 23, reducing the cost of borrowing by 25 basis points (bp) to 4.00%. Praising the government's efforts to get growth back on track, stabilize the forint and subdue inflation, Hungary's central bank surprised by insisting it will push on with the easing cycle to bring rates down to 3.0-3.5%. That's likely bad news for the banks holding foreign currency loans.

In a rare appearance to accompany a monthly monetary policy council meeting - a practice he halted when he took the helm in March - Governor Georgy Matolcsy stressed "we are not done yet" with the rate cuts. Adding that similar to the European Central Bank, the Hungarian version will introduce a "forward guidance framework," he obliged a frank announcement that he sees 3.0-3.5% as the bottom of the cycle.

Matolcsy also insisted that further cuts are only possible, but necessary to support growth. However, the 3.0-3.5% floor is likely to be achieved more slowly, he added, noting that smaller steps of 10bp could be implemented.

"With inflation at the lower bound of the target, growth still sluggish, and the forint relatively stable (and below 300) against the euro, there was little reason not to cut, considering past practice," Nordea analysts suggest.

However, there's plenty of concern amongst commentators that while consumer prices appears tamed for now, the currency remains at risk from any fresh fall in appetite for emerging market debt.

The path towards another 50-100bp of cuts from the central bank is fraught with such danger, which piles extra pressure on the government to deal with the major remaining brake on policy: the huge volume of forex debt held by Hungarian households. The cabinet is scheduled to discuss two options for legislating changes to loan contracts on July 24, with the banks watching nervously for news that they will be hit for huge losses once again.

Until that issue is solved, currency risk stalks further easing. At the same time the ruling Fidesz party is now revving up populist policy ahead of elections next year. Indeed, some analysts suggest that Matolcsy's "pragmatic" and "practical" move to cuts of 10bp or slower reflects the MNB's quest to satisfy two seemingly opposite tasks - supporting the government's "unorthodox" policy and keeping investors happy.

"We see no useful purpose in fine-tuning rates like this save for the ability to keep cutting rates while keeping markets onside," writes Peter Attard Montalto at Nomura. "The impact on the economy should be minimal. Politically, the bank can say it is still cutting even under riskier market conditions - a key issue given the run-up to the elections next year." Matolcsy even said the steps "could be smaller, but we must have some kind of meaningful unit."

"[A]lthough external debt has fallen, it's still extremely high. Hungary remains highly vulnerable to a deterioration in investor sentiment," notes Capital Economics. "If capital inflows dry up, the forint will weaken, thus pushing up the local currency value (and debt servicing costs) of foreign currency denominated debts. This, in turn, will cause the economy to slow ... we think the NBH may be treading on thin ice."