December 20, 2016 / 1:11 PM / 8 months ago

UPDATE 2-Hungary keeps key rate steady, caps 3-month deposits further

(Adds central bank comments, updates forint, adds analyst)

* Base rate unchanged at 0.9 pct, as expected

* Overnight borrowing/lending rates also steady

* Caps funds in 3-month deposit tool further in Q1

* Ready to ease monetary conditions further if needed

By Gergely Szakacs and Krisztina Than

BUDAPEST, Dec 20 (Reuters) - Hungary's central bank kept its base rate on hold as expected on Tuesday and opted for unconventional monetary easing, squeezing out more funds from its main 3-month deposit tool into the economy in order to drive down borrowing costs.

With the bank ruling out further cuts in its main policy rate, a reduction in the stock of its 3-month deposits has emerged as its key tool to curb market interest rates.

As the bank's tools to boost the economy are running out, the government has embarked on massive fiscal stimulus with wage hikes and a sharp cut in the corporate tax rate, as Prime Minister Viktor Orban gears up for 2018 elections.

"Further unconventional (central bank) measures are possible, but the room of manoeuvre has narrowed," analysts at CIB Bank said in a note. They expect the base rate to stay unchanged possibly until the end of next year.

On Tuesday, the Monetary Council decided to set a 750 billion forint ($2.50 billion) cap on the stock of three-month deposits effective at the end of the first quarter of 2017, slightly above a Reuters analyst consensus of 700 billion. At the end of November, 3-month deposits stood at 936.8 billion forints. The end-2016 cap is set at 900 billion forints.

"The Council expects that this decision ... will mean the crowding out of at least HUF 100-200 billion additional liquidity from the deposit facility," the Council said.

The rate-setting body also said it was ready "to ease monetary conditions further using unconventional, targeted instruments" if needed to achieve its medium-term inflation target of 3 percent.

All 20 analysts in a Reuters poll had forecast no change in the policy rate and their median forecasts showed it could stay on hold throughout this year and next, before rising to 1.3 percent by end-2018.

At 1432 GMT, the forint, which has weakened in the past weeks due to global uncertainties, traded at 310.90 versus the euro, firming from 311.10 before the rate decision.

After cutting its overnight lending rate for the second month in a row in November, the bank also kept the corridor around the base rate unchanged on Tuesday.

Inflation has hovered around zero for years and the bank says price growth will approach its 3 percent policy anchor only in 2018.

Hungary sold three-month Treasury bills at a yield of 0.06 percent earlier on Tuesday, the lowest on record. (Reporting by Gergely Szakacs; Editing by Catherine Evans)

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