Bond yields rise on fear move will fuel inflation

The yield on government bonds climbed on higher-than-expected rise in prices of oil products and higher cut-off for the government bond auction.

The rise in fuel prices raised expectations of an early hike in short-term interest rates by the Reserve Bank of India (RBI) to manage inflation.

Dealers said the decision came as a surprise. Though the move might reduce the government’s subsidy burden, it would push inflation.

The yield on 10-year benchmark (7.80 per cent bond 2020) at close of trading was 7.65 per cent, higher by eight basis points over the previous close of 7.57 per cent, according to Negotiated Dealing System data.

Moses Harding, head, global markets group, IndusInd Bank, said the decision came ahead of time. The market was expecting that the government would raise fuel prices after liquidity improves. Liquidity has been under strain for the last few weeks due to huge amounts moving out of the system for payment of spectrum fees by telecom players. The payment of the first instalment of advance tax by individuals and companies has also led to money flowing out of the system.

Another reason yields rose was the higher cut-off yield at a bond auction. RBI fixed 7.62 per cent as cut-off for the 10-year benchmark paper, five basis points more than the previous close. Dealers said the market had factored in the yield movement on the 10-year benchmark (7.80 per cent 2020) in the band of 7.50-7.75 per cent.

In last few weeks, the yield has tended to be at the lower end of the spectrum. So, even if yields harden due to the fuel price hike, they may still remain within the band, albeit at the higher end, according to the head of a public sector bond house.

The rise in yields has also fuelled expectation that RBI may increase policy rates – repo and reverse repo – earlier than first quarter policy review on July 27.

Srinivasa Raghavan, head of treasury, IDBI Gilts, said, “The oil price hike may mean RBI action earlier than expected.”

“With economy on the road to recovery, as reflected in industrial production, non-oil imports and bank credit, coupled with inflation remaining sticky, a 75 basis points tightening is expected in 2010. RBI may raise rates in the coming week,” said Rohini Malkani, economist, Citi India.