The EU opened the way to talks with Hungary on financial aid on Wednesday, ending a five-month dispute over the independence of its central bank, but it kept pressure on Prime Minister Viktor Orban by sending a row over the judiciary to Europe's top court.
The European Commission said it was satisfied with Budapest's assurances that its central bank law would be brought back in line with that of the European Union, allowing Hungary to discuss a precautionary International Monetary Fund loan to stabilise its indebted economy.
Guarantees have been provided by the Hungarian authorities vis-a-vis the independence of the central bank... which means that the Commission is today prepared to discuss financial assistance as requested by Hungary from the EU and the IMF last November, Commission spokesman Olivier Bailly told reporters.
Hungary's forint surged near to a two-month high against the euro in response. The Budapest stock market jumped more than 4 percent and the government's cost of borrowing over 10 years from bond markets fell by almost 0.8 percentage points to less than 8 percent.
Hungary is seeking a standby loan facility worth up to 20 billion euros, the agreeing of which the government hopes will ease market nerves over Orban's unorthodox policies and bring its borrowing costs back to more affordable levels.
Some economists estimate delaying the talks over the past four months has cost Budapest 100 billion forints (277 million pounds) in higher debt servicing costs due to the uncertainty.
The decision ends months of acrimony between Budapest and Brussels. Even in a visit to Brussels this week, Orban had accused the EU of setting unfair preconditions for talks, while the Commission has questioned the quality of democracy in Hungary.
The Commission said no date had yet been set for talks and it also said it was asking the European Court of Justice to rule on Budapest's decision to revise laws on data privacy and the retirement age of judges.
These issues will not hold up IMF loan talks, but given the lack of trust on both sides, analysts sounded a cautious note.
The risk is still there that after stepping into the next stage, the market pressure will ease and the Hungarian government's commitment to reaching a deal could loosen and the whole process could slow down, said Citigroup's Eszter Gargyan.
Orban's government has enough currency reserves to service its foreign debt until about the end of the year, analysts say.
THROWING IN THE TOWEL
The government said it had agreed not to expand the central bank's rate-setting Monetary Council and appoint a third deputy governor before Governor Andras Simor's term expires next year.
But EU diplomats said Orban had refused in talks with European Commission President Jose Manuel Barroso to give in on a move to cut central bank salaries which was at the heart of the dispute with Brussels.
Critics say the wage cut is part of a sustained attack on the current leadership of the bank by Orban's Fidesz party.
The prime minister, who defended his democratic credentials and portrayed himself as a leading European reformer in a speech in Brussels on Monday, says the cuts are part of his public sector reform and not directed at the central bank.
It was not immediately clear if Barroso and the EU's top economic official Olli Rehn bought that argument.
Analyst Timothy Ash at RBS in London said the Commission was throwing in the towel and agreeing to allow Hungary to begin negotiations.
But talks with the IMF are likely to be difficult and Rehn has said the government must live up to its commitments.
While lenders are not expected to challenge Orban's flat income tax, a key plank of the government's policy, they may ask for cuts in the cost of labour on low-skilled workers, and a strengthening of the budget oversight panel, the Fiscal Council.
Other sticking points during the negotiations could include Budapest's new taxes on financial transactions and telecoms services, which Hungary flagged in its regular fiscal report to Brussels this week. The IMF may push for sustainable spending cuts instead.
At stake is also the EU's credibility in trying to rein in a government seen as failing to keep its budget deficit in check. EU finance ministers in March froze Hungary's access to half a billion euros in aid over the issue.
The EU may have ceded ground to Hungary, but you won't see money coming onto the table until changes are implemented. It would be surprising if they put any money up without that, said William Jackson, an economist at Capital Economic in London.
(Additional reporting by Jan Strupczewski in Brussels, Sujata Rao in London and Gergely Szakacs in Budapest; editing by Rex Merrifield and Patrick Graham)