(Adds more comments, detail, background)
By Krisztina Than and Balazs Koranyi
BUDAPEST, Jan 5 (Reuters) - Hungary's central bank wants to cut rates as fast as possible because falling inflation and a recession warrant much lower rates, but rate cuts must not upset financial stability, Governor Andras Simor told Reuters.
Simor also said in an interview on Monday that there is a good chance that the bank will significantly undershoot its 3 percent medium-term inflation target, and the target would be achievable even with a weaker forint exchange rate.
The bank has cut rates in three steps by a cumulative 150
basis points to 10.0 percent
"The Monetary Council has declared that we would like to lower the base rate as fast as possible because both real economy prospects and inflation prospects would justify a significantly lower interest rate level than the current level," Simor said.
"We can continue cutting rates only at a pace which, in our view, does not pose a threat to the stability of the banking system and capital flows," he added.
The forint, which slumped to an all-time low of 286 versus the euro in October before the rate hike, has recovered significantly since then, trading at around 266 on Monday.
Simor said it was more important to safeguard this relative stability in Hungary's financial markets than risk upsetting it with more aggressive rate cuts, even though the inflation outlook would allow much faster easing.
Hungary's annual inflation rate slowed to 4.2 percent in November and is expected to drop further this year. A rate below 2 percent is expected in 2010 mainly because world commodity prices are falling.
The country, which joined the European Union in 2004, is heavily reliant on foreign capital flows to finance its budget and current account deficits and large external debt.
"We'll lower interest rates as fast as markets will allow us," Simor said.
"There is a good chance that we will significantly undershoot the inflation target on the time horizon of the inflation targeting system, which is 1 1/2 to two years," he said.
WEAKER FORINT NO RISK
The governor said the bank wants to prevent excessive forint volatility and that is why it hiked rates in October when the forint fell sharply, but the inflation target could be achieved even with a weaker currency.
"The inflation target can be achieved not only with the current rate versus the euro, but it could be comfortably achieved with a weaker exchange rate as well," he said.
"From an inflation perspective, I think the inflation target could even be achieved with a forint at 286 (versus the euro) which was the weakest the forint got to during the last three months," he added.
Simor said the main concern for the bank was not inflation, but dismal growth prospects, as the economy is expected to slide into recession this year, on falling demand in main European export markets and slowing domestic consumption.
In November the bank projected that the economy would contract by 0.2-1.7 percent this year, but Simor said the outlook has worsened since then due to external factors and a slowdown in lending activity in the banking sector.
He said this also posed a risk to the budget, but he trusted the government would take additional measures if needed to cut the deficit to 2.6 percent of GDP, as planned.
"Risks on the revenue side of the budget have probably increased (since the November inflation report) as growth prospects have deteriorated," he said.
Simor said due to a drop in the deficit and inflation, Hungary moved closer to meeting the criteria of euro adoption, but he declined to say when a euro target date could be set.
"I said that in the first half of 2009 we will sit down with the government and we will talk about this (discussing euro introduction). What the outcome of this discussion will be, we will see then, I cannot say anything more," he said.
(Reporting by Krisztina Than and Balazs Koranyi; Editing by Kenneth Barry)