Bond yields rise due to profit booking, fear of inflation inching up

Expectations of a cut in repo rate by RBI had started building up due to softening retail inflation

Government bond yields rose on Thursday owing to profit booking by traders and fears that inflation might rise again. The yield on the 10-year benchmark bond, which has been falling in most of the trading sessions in recent times, increased by four basis points to close at 8.22 per cent on Thursday.

Expectations of a cut in the repo rate by the Reserve Bank of India (RBI) had started building up owing to softening of retail inflation. Retail inflation dropped to an all-time low since the country started computing Consumer Price Index (CPI) in January 2012. Retail inflation for October dropped to 5.52 per cent, down from 6.46 per cent in the previous month. RBI has set a retail inflation target of eight per cent by January 2015 and six per cent by early 2016.

“Yields rose due to profit taking and the government's decision to hike excise duty on petrol and diesel. Concerns are there that inflation may again inch up, delaying chances of a rate cut,” said the head of treasury of a state-run bank.

The government has raised the excise duty on petrol and diesel by Rs 1.50 a litre to mop up an additional revenue of Rs 13,000 crore.

The yield on the 10-year bond yield was pushed to a 15-month low on Wednesday, on optimism that cooling inflation would make room for RBI to cut the repo rate.

Owing to the fall in bond yields in the debt funds category, medium- and long-term gilt funds have emerged the best performers in the past six months.

“Investors should not look at investing in gilt funds with a short horizon. The horizon should be reasonably medium-term because it is a volatile asset class. RBI may not cut the repo rate in the December policy review, but the direction is for interest rates to go down,” said R Sivakumar, head of fixed income and products at Axis Mutual Fund.