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Hungary was forced to cancel a bond swap auction amid an escalating financial and political crisis that investors fear could trigger another dangerous shockwave in Europe.
The Budapest government saw borrowing costs soar and the currency plunge as traders bet that international authorities may abandon Hungary, letting it become the first European Union country to default on its debts.
The florint fell more than 1pc to a record low against the euro and bond yields soared over 10pc. The Hungarian government, which has defied Brussels by introducing a raft of radical constitutional reforms, called off its plans to swap old debt for new because it would be too expensive.
Traders, already rattled by the advancing eurozone debt crisis, including a drastically discounted rights issue by UniCredit, were unnerved by the emergence of a new front in central Europe. France's CAC index fell 1.6pc, while Germany's Dax and the FTSE 100 dropped 0.6pc each.
Elsewhere, Spain's banks will be required to find an extra €50bn in provisions against potential losses from devalued property, as reported in the Financial Times.
"These events can have a habit of sparking up from being 'too local and too small' for major players to care about to sudden more unpredictable eruptions of risk contagion," 4Cast analysts said in a note.
Benoit Anne, of Societe Generale, said in a note: "We are very near boiling point in Hungary with a crisis that may escalate into something much more serious than a simple macroeconomic crisis... The EU is extremely concerned about the latest political developments and the potential EU response will – no doubt – be harmful to investor confidence."
Hungary, which must roll over nearly €5bn of external debt this year, is due in February to start repaying a loan to the International Monetary Fund (IMF) that saved the country from financial collapse in 2008.
Borrowing costs rose in other central European countries today including Poland and Czech Republic. There are also fears about the exposure of European banks to Hungarian debt, particularly Austrian and Italian institutions.