Fitch cut Hungary to the brink of junk debt status, saying deficit-cutting measures in the 2011 budget passed by parliament on Thursday could send the country down an unsustainable fiscal path towards a further downgrade.

To get the budget within EU limits in 2011, the government is relying on unorthodox, one-off revenues, making markets fearful the fiscal gap will bulge again after 2012 unless more durable measures are introduced.

Fitch outlined similar concerns, becoming the last of the three main agencies to cut Hungary's debt to within a single notch of non-investment grade status and also placing a negative outlook on the new BBB- long-term foreign currency rating.

The action sent the forint currency down 1 percent just before the ruling centre-right Fidesz party used its parliamentary majority to win approval for the budget by 257 votes to 119.

The Economy Ministry said the downgrade by Fitch was "regrettable but not surprising," adding that it expected rating upgrades down the line.

Next year's deficit cut to below the EU ceiling of 3 percent of GDP will make Hungary a top fiscal performer in the 27-member bloc, but the government will do so by raking in temporary taxes, including new levies on profitable foreign businesses, and up to $14 billion in private pension savings, putting it on a collision course with markets and voters.

"The new Fidesz government ... has set out fiscal plans that go in the wrong direction," Fitch said. "These plans could worsen the underlying medium-term budget outlook by around 4 percentage points of GDP over 2011-2012.

"A significant rise in the risk premium or absence of sustained economic recovery would also have adverse consequences for debt dynamics and the rating."

The government is due to announce a programme of broader structural reforms next February that markets hope will put the country on a sustainable fiscal path.

Fitch said robust GDP growth and implementation of proper fiscal consolidation could lead to "positive rating action".

A MORE DOVISH CENTRAL BANK?

But the government added to pressure on Hungarian assets by approving new rules to let a parliamentary committee fill all vacancies on the central bank's seven-strong monetary council (MPC) when the mandates of four policymakers expire in March.

The move, which will put Governor Andras Simor and his two deputies in a minority in the council versus the new members, is widely seen as an attempt by Fidesz to force the central bank to ease monetary policy to advance the government's pro-growth agenda.

The bank has raised interest rates by 50 basis points to 5.75 percent over the past two months to fend off price pressures fuelled by tax changes.

"This means that new MPC will be dominated by members who are likely to be relatively more dovish," Citigroup said.

"Taking this into account we expect monetary tightening probably will not be continued after March 2011 unless there is a substantial increase in risk aversion."

That could happen if Budapest fails to heed market pressure to come up with a meaningful longer-term fiscal package in February.

Economy Minister Gyorgy Matolcsy has pledged a series of reforms saving 600-800 billion forints ($2.9-$3.8 billion) a year to make the deficit cuts sustainable in the long run.

"Should the package disappoint and only include cosmetic changes ...a downgrade into junk category would be a definite possibility. There simply is no more time to beat around the bush, in our view," said Gyorgy Barta, analyst at CIB Bank.

ALL EYES ON REFORM PLANS

The forint fell nearly one percent to trade at 278.25 against the euro by 1510 GMT on Thursday after Fitch's ratings move, while bond yields rose only about 5 basis points as markets had been expecting the fresh downgrade.

Having broken off ties with the International Monetary Fund in July, Hungary is now fully reliant on markets to finance its deficit and debt, although it still has 2.5 billion euros of unused IMF/EU funds if the need arises.

It has smoothly issued government debt this year and plans to issue foreign bonds worth 4 billion euros "as soon as possible" next year to refinance debt and begin repaying parts of an IMF/EU loan that ushered it through the global financial crisis.

February's reforms will also need to ensure that Hungary's public debt -- at around 80 percent of GDP the highest in central Europe -- is put on a firm downward path after a one-off decline next year due to changes in the pension system that private pension funds have said amount to nationalisation.