* Fidesz has cemented powers ahead of Oct. 3 municipal vote
* PM Orban faces two limits: financial markets and EU
* 2011 budget in focus after local vote
* EU presidency in 2011 next key challenge
By Krisztina Than
BUDAPEST, Sept 22 (Reuters) - Hungarian Prime Minister Viktor Orban has one of the strongest political mandates in Europe but he faces two constraints beyond his control: financial markets and the European Union.
These two forces will continue to pose serious challenges to Orban, with the first big test after October municipal elections when his centre-right government will have to present a credible 2011 budget to reassure investors.
Investors and rating agencies will scrutinize this budget to decide whether to give his centre-right government the benefit of the doubt after it broke ties with the International Monetary Fund and baffled markets with confusing messages since April.
If they are convinced the government is committed to deficit reduction and will put high public debt on a declining path, Hungary can escape a downgrade in its sovereign rating -- and there is chance for a "virtuous circle" in which investor trust returns and risk premia on Hungarian assets fall.
Even then, risks will remain about the country's ability to finance its debts from markets in coming years without an IMF satefy net amid still fragile global investor sentiment.
Orban, 47, whose Fidesz party won a historic two-thirds majority in parliament in April, is seen as a shrewd, pragmatic politician who is planning to stay in power beyond the next general elections, due in 2014.
For this, he needs to put the economy firmly back on a growth track and create jobs.
"There are only two issues that are now posing barriers to his powers: markets -- which he is trying to manipulate in a manner that I have never seen anywhere in Europe -- and the other very painful limit for him is the common EU decisions," said an EU diplomat in Budapest.
Since his April election landslide, the yield on Hungarian 5-year bonds has risen 110 basis points to 6.8 percent, and the forint currency has fallen by 5.7 percent against the euro. However it had fallen as much as 11 percent at the height of the crisis on July 19.
TIGHTENED GRIP
Orban has tightened Fidesz's grip on key institutions, and delivered on symbolic pledges such as easing cizitenship for ethnic Hungarians in neighbouring states while giving little detail on his fiscal plans.
He tested markets' patience by seeking budget leeway to boost growth at a time when the EU is trying to rein in public deficits, and by pushing what some observers see as an "economic nationalist" agenda.
Orban has favoured domestic firms, taxed banks heavily, lashed out at "speculators" and stood up to the IMF.
His government has committed, reluctantly, to cutting the budget deficit below 3 percent of gross domestic product next year under heavy pressure from the EU and a weakening forint.
Hungary will be in the forefront of attention from January when it takes over the EU's rotating presidency with key budget and economic issues on the agenda.
But before that, the period after the October vote will be critical to show whether Orban will use his mandate to restore fiscal discipline and launch potentially painful reforms in healthcare, local governments and at loss-making state firms.
"The key to market financing rests with the government's ability to fill with credible detailed plans the recently announced low deficit target," said Janos Samu, an analyst at Concorde in Budapest.
ON A MISSION
Orban swept to power with a mission to make Hungary a strong economy again after eight years of Socialist rule, promising to cut taxes and create "one million jobs in 10 years".
His Fidesz party has managed to maintain its big poll lead at around 60 percent among decided voters since April elections and is expected to score a major win again in the local vote.
But it has done so by saying different things to different audiences, promising voters it will regain financial independence from lenders and ruling out austerity, while trying to reassure markets with budget discipline pledges when needed.
This confused markets and led to falls in the forint and bonds in June -- when some Fidesz officials likened Hungary's fiscal situation to Greece -- and in July when Hungary's talks with the IMF and EU unexpectedly collapsed.
"Fidesz seems to forget we are in a globalised world and every word has an impact outside," another EU diplomat said.
"There are such tensions between the intention of regaining economic sovereignty and the small fiscal room of manoeuvre ...that it's very difficult to build a consistent economic policy on that," added Peter Tolgyessy, a political analyst.
Orban will have a tough task to meet fiscal targets and beef up the economy. For the time being, investors remain cautious.
"The government, in principle, holds the power to... create a virtuous circle in which a stronger forint and lower risk premium could remove the threat of rate hikes and allow government bonds to rally," Barclays Capital said in a note.
"However, there are many `ifs' in that equation."
(Reporting by Krisztina Than; Editing by Paul Taylor)