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UPDATE 3-Hungary central bank to use one-week depo rate as 'fast response', deputy governor says

* Bank in a bind between weak recovery, high inflation

* Forint weakening a factor if it boosts long-term inflation

* Bank says to respond with appropriate tools if needed

* QE programme to be reviewed before purchases approach limit (Updates with Thursday’s tender, analyst comment)

BUDAPEST, Oct 1 (Reuters) - Hungary’s central bank will use its one-week deposit rate to combat inflation risks stemming from volatile global sentiment that has weighed on emerging-market assets, including the forint, Deputy Governor Barnabas Virag told Reuters on Thursday.

Renewed risk aversion, which has also weighed on Hungarian assets, is the biggest risk to the inflation outlook now, Virag said. Inflation was expected to ease below 3.5% by the end of the year from around 3.9% seen in September, he said.

The pandemic had presented the bank and Governor Gyorgy Matolcsy with the toughest challenge of his seven years at the helm of the National Bank of Hungary.

The economy has plunged into recession and recovery now looks slower than previously expected, while inflation is forecast to rise to an eight-year high this year. The forint’s losses pose further inflation risks down the line.

On Thursday, the bank kept the interest rate unchanged at 0.75% after unexpectedly raising it by 15 basis points last week, which gave some support to the forint, though most analysts said more may be needed later.

“We still want to avoid this uncertain global environment raising inflation risks through any channel,” Virag said in an interview.

Asked about last month’s decline by the forint, Virag said the bank factored it into its policy to the extent the moves affected long-term inflation developments and expectations.

“We will react to the situation accordingly,” Virag said. “If this environment leads to a further increase in inflation risks, then as we have done so in the past, we will take the necessary steps going forward.”

At 1008 GMT, the forint, which sank to record lows at 370 per euro in April, traded 0.8% stronger on the day at 360.65 versus the euro.

Virag said changing the one-week deposit tool was an appropriate way to handle risks stemming from higher risk aversion. It allows the bank to respond quickly and predictably, guiding expectations.

“Our view is that the 15 bps hike has not fixed the vulnerabilities and fundamental problems,” Societe Generale economist Marek Drimal said in a note before Thursday’s tender.

“While the (NBH) has the highest nominal rates within CEE3, its balance sheet keeps expanding at 35-40% yoy, on par with (or slightly higher than) the openly accommodative (National Bank of Poland’s).”

Virag also said the bank wanted to maintain a lasting presence in the bond market with government bond-purchase programme, a shift from the bank’s previous stance -- that it considered the measure a temporary crisis-fighting tool.

With around 410 billion forints ($1.33 billion) of bonds bought under the scheme so far, the programme is on track to reach around 900 billion forints by the end of this year at the current pace of 40 billion forints worth of weekly purchases.

Virag said the Monetary Council would need to review the programme, including its total size and possibly the amount of weekly purchases, well before its bond holdings approach the current 1 trillion-forint limit.

“We will fine-tune our programmes wherever necessary,” Virag said. A 33% limit on the bank’s holdings in any given bond series was not etched in stone, he said, as some longer-dated series were already near or at that mark. ($1 = 307.94 forints) (Reporting by Krisztina Than and Gergely Szakacs; editing by Larry King)

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