Bond yields seen choppy ahead of policy review

Yields on government bonds may ease on expectations that the central bank wouldl take a dovish stance in its coming policy review but a higher rate of inflation may limit the fall. The Reserve Bank of India (RBI) will announce its mid-quarterly monetary policy review on the coming Friday.

Last Friday, yields on the 10-year benchmark government bond closed at 8.53 per cent, or 12 basis points lower than a week before. Yields eased on talk that the central bank might consider a reduction of 25-50 basis points in the Cash Reserve Ratio (CRR) from the current six per cent. This is despite top RBI officials reiterating that CRR was not just a liquidity tool but one for monetary policy, and any relaxation on that front may indicate a shift in stance from anti-inflationary to pro-growth.

“The swift move in the bond and interest rate swap market has taken into account a 500bps cut in CRR and a rate cut soon thereafter,” said Moses Harding, head-global research, IndusInd Bank. The overnight indexed swaps (OIS) eased in line with gilt yields and the one-year OIS closed at 7.75 per cent, while the five-year OIS rate closed at seven per cent. He said the market would be nervous ahead of the policy announcement, weighing the risk of consequences if RBI prefers to leave things unchanged. Doing so would drive the 10-year yields back into 8.65-8.75 per cent and the five-year OIS into 7.25-7.35 per cent.

“Traders will watch for data on inflation and industrial production before the policy announcement,” said a treasury official of a public sector bank. The Index of Industrial Production data for October will be released tomorrow, while the Wholesale Price Index (WPI) for the month of November will be released on Wednesday.

Overall headline inflation rate is expected to ease, in line with the falling trend of food inflation. “Assuming a year-on-year rise of 7.4 per cent rise in manufactured goods inflation, we estimate November WPI to be nine per cent,” said Taimur Baig and Kaushik Das, economists at Deutsche Bank. Inflation was at 9.73 per cent in October and 9.72 per cent in September. Industrial production is also expected to fall, reflecting a slowing in economic activity, amid high interest rates.

Liquidity is expected to worsen, as the deadline for making advance tax payments falls this week. Banks have been borrowing an average of Rs 85,000 crore daily from RBI’s repo window since the start of this month.