Bond yields to see correction on RBI policy day

Bond yields are set to see a correction on December 2, when the Reserve Bank of India (RBI) will announce the fifth bi-monthly monetary policy. This is because the bond market is bullish on expectations of a cut in interest rate due to softening inflation numbers. But experts believe RBI would take a cautious stance.

On Wednesday, the yield on the 10-year bond was pushed to a 15-month low on optimism that cooling inflation will make room for RBI to cut the repo rate. The CPI inflation data was released after market hours. Retail inflation has dropped to an all-time low since the country started computing Consumer Price Index (CPI) in January 2012.

Retail inflation for the month of October dropped to 5.52 per cent, down from 6.46 per cent the previous month. RBI has set a retail inflation target of 8 per cent by January 2015 and 6 per cent by early 2016.

“If the rate cut doesn't happen on December 2, then the bond market could give up all the gains. The yield could then climb up to 8.25-8.30 per cent. The market should be cautious,” said N S Venkatesh, executive director and head of treasury at IDBI Bank.

However, in the interim, the rally is seen continuing. “The yield on the 10-year bond may fall to 8.10 per cent in the run-up to the monetary policy. However, on the policy day, there could be corrections,” said a bond trader with a state-run bank. The yield on the 10-year bond ended at 8.16 per cent compared with previous close of 8.19 per cent.

Last week, RBI's Deputy Governor H R Khan has cautioned industry and market players against “celebrating the falling retail inflation too early". “Inflation still has a long way to go in terms of input costs, wage burden, food prices. There are structural issues. Rural areas are also seeing large inflation,” Khan said.

Many economists believe for the rest of the financial year, RBI shall hold the repo rate at 8 per cent. However, experts believe when the rate cut cycle begins, there may be deep cuts. “By then they would be fully convinced that inflation indeed has come under control. For the October CPI data, easing of global commodity prices and statistical base effect has contributed greatly to softening in inflation,” said Rupa Rege Nitsure, chief economist and general manager, Bank of Baroda.

RBI has kept the repo rate or the rate at which banks borrow from the central bank, unchanged at 8 per cent since the January monetary policy review.